Are You Keeping Up With Inflation?

If the government says the cost of living went up 4 percent last year and you get a 4 percent pay hike, you're breaking even, right?

Not necessarily.

There's more to inflation than meets the eye, particularly as it relates to the wallet of the everyday consumer.

It probably comes as no surprise to you that prices have been going up -- about 4 percent over last year, according to the U.S. Department of Labor's Bureau of Labor Statistics, or BLS. And a 4 percent rise in income, theoretically, should offset that. But it doesn't always work out that way.

First, it's important to understand what inflation is and how it's calculated.

"Inflation affects consumers whenever they spend their money," says Dan Seiver, professor of finance at San Diego State University. In an effort to try to figure out exactly how much, the Bureau of Labor Statistics sends people out each month to determine the prices of about 80,000 products and services that consumers use regularly. Among the items and services priced are food, beverages, housing, apparel, transportation and medical care. By comparing the costs of items and services monthly, the BLS can gauge how much, more or less, consumers must pay each month for the same services.

While price fluctuations are important to determining inflation, there's another factor that is equally crucial to understanding its impact. Consumers spend more of their money on certain categories. For example, you're likely spend more of your budget on your mortgage or rent than you do on entertainment. To figure out what spending categories are the most important to consumers, the BLS also conducts surveys to monitor consumers' spending habits. With this information, the Bureau assigns a weight to the various categories so an increase in the average cost of housing, for example, will affect inflation more than an increase in the average cost of entertainment. With all of this information, the Bureau comes up with the Consumer Price Index, or CPI, which measures inflation over time.

Inflation's real cost

Despite the Bureau's best intentions, "The average person doesn't need the Bureau of Labor Statistics to tell them where prices are going," says Jared Bernstein, economist and author of "Crunch: Why Do I Feel So Squeezed? (and Other Unsolved Economic Mysteries)."

"The way people tend to experience these changes in prices is they recognize that their incomes are either going further than or not as far as they used to. Someone might buy a couple of bags of groceries, fill the car up on the way home and find out that they have far less to put in the college fund than they did last month."

The national inflation rate can give you a general indication that prices are on an upward trend, but the actual impact of inflation will vary from person to person. "The index is designed to reflect a very specific American family and their spending habits," says Seiver. "If your consumption spending does not look like that typical family, then you could be experiencing more or less inflation."

Increases in salary can help off-set the inflation rate >

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