Working with inflation

INFLATION is a variable which every individual takes into account regardless of the line of work they are in. Starting from the coffee we drink to the income we make- every monetary aspect is affected by inflation. When inflation is going up, we intuitively realize that we need to earn more to diminish the effects of rising prices. But exactly how much more do we need to earn? Using inflation figures to calculate our own well beings is not very difficult. Inflation figures are available and interpreting them correctly can help us to have a better insight into our incomes.
Let us see an example used in elementary economics. Suppose a person's income is Tk. 100 which increases by 10% to Tk 110. Inflation on the other hand rises by 15%. It is quite apparent that the real income (adjusted with inflation), has fallen by 5%, making the person worse off.
So how do we make sure that inflation doesn't erode our incomes? In order to remain on the same standard of living, our nominal incomes must rise proportionately with inflation. In order to attain a higher standing of living, one needs to attain an income greater than the proportion of inflation.
This may seem straight forward where all we need to look at is the increment in income and the rate of inflation. However the story does not end here. What if someone's income is not increasing every year; rather it is rising once in 3 years? In that case which inflation rate do we look into? The answer is that we must take in inflation rates of all 3 years into account.
Suppose in 2012 my income is Tk. 100 and inflation rate is 5%, in 2013 say inflation rises to 8% and falls back to 5% in 2014.  How much should my income increase in 2014 to negate the effects of inflation? It can be easy to assume that since inflation is at 5% in 2014, a proportional rise in income would suffice to remain on the same standard of living. However inflation rates of all the years should be taken into account, which means in 2014 a person's income should be Tk 119.4. This income will only suffice to wipe out the effects of inflation and would not make him any better off than he was back in 2012.

The writer is the head of research at The Daily Star and can be reached at faaria.ts@gmail.com