Why cost of living so high?
Simple explanation and solution for making smart buying choices during a price hike
You're confused, girl? You don't get why everything is so expensive? Yeah, me too
In the last few months, I've been asking myself this question all the time
Though I have a decent job with good income, rent takes up half of my pay check, and even grocery shopping has become costly. But complaining doesn't change anything
***Before I go on, this article is mainly about why prices are high. The article ends with a video that shows a solution using ChatGPT and also a prompt. If you're interested in the solution, check this out instead of reading the whole thing.
There are two types of people in the world
Those who want to understand and gain insight into the inner workings of the economy, and those who just get upset and talk about it without taking action.
Understanding why things happen in our economy helps us make better decisions and intelligent predictions for the future.
I'm sure you would have hesitated to take on a thirty-year mortgage or finance your car if you knew the large-scale money printing to respond to Covid would lead to high inflation and interest rate hikes, for example
When you have the right information, you can make wiser buying decisions.
Economics isn't a complicated field to understand, like some people think. I'm going to explain in a kid's way words we hear in the media like "inflation" but don't really understand
It's important to note that I am not a professional economist; I'm just someone with a desire to learn
Before diving in, first things first
There are two main reasons for high living costs
1. Inflation- FED prints money during COVID, so prices go up
2. Russian invasion of Ukraine - contributed to even higher inflation and caused some instability in food and energy prices
Inflation
Inflation is a term that's thrown around quite often, but how well do we actually understand what it really means?
Imagine there's a toy store and each toy costs one cookie. Now let's say there are too many cookies floating around, yet the number of toys in the store remains the same. In this scenario, the store owner might decide that it now costs two cookies to buy one toy.
This means your cookies are worth less when it comes to buying toys and this is the essence of inflation: when things cost more than they used to.
I'm passionate about understanding the origins of names, what they signify, and how it gives greater insight into our world.
What is the origin of the term inflation?
Historically, it was used to describe the act of filling something with air or gas.
In an economic context, "inflation" was adopted to describe the "blowing up" or expansion of the money supply or the general rise in prices of goods and services.
Just as when you inflate a balloon and it expands, in economic terms, when there's inflation, the prices of things generally expand or go up.
By now you must be asking the same question I asked myslef: What are the conditons for an inflation to accure?
Think of inflation like a game of musical chairs.
1. Too Much Money: What if everyone playing the game suddenly had two or three chairs to sit on instead of just one? There's too much of something (in this case, chairs).
In the real world, when there's too much money going around and not enough things to buy with it, prices can go up. It's like everyone having a lot of allowance money but only one toy store in town.
2. Not Enough Goods: What if half the chairs disappeared from our game, but the same number of players remained? Everyone would rush to find a chair! If there aren't enough toys, clothes, or food being made, but everyone still wants them, the prices of these items might rise because they become more scared.
3. Expectations: What would happen if everyone thought that there would be fewer chairs in the next round? They might rush even faster to grab one in the current round. In the same way, if people think prices will go up in the future, they might buy more stuff now, which can actually make prices go up.
So, inflation usually happens when there's too much money, not enough goods, or when people think prices will rise in the future. It's like a big game of supply (how much stuff there is) and demand (how much people want that stuff).
Funny fact
I was talking to my Mom about this topic the other day and she told me something interesting. In the Soviet Union, when I was in my 20s, you couldn't talk about inflation, she told me. It was taboo and people were brainwashed that capitalism caused it. The only way to talk about inflation was "healthy price expansion"
There were some crazy people running the Soviet Union
But here comes the interesting part
As a consumer, how does understanding inflation help me?
Here are five reasons
1. Budgeting and Planning: Knowing that prices tend to rise over time helps you plan and budget for the future.
2. Salary Negotiations: When negotiating a raise or considering a job offer, being aware of inflation can help you ensure that your salary keeps pace with the rising cost of living. If your salary remains the same while prices rise, you're effectively earning less in terms of purchasing power.
We need to distinguish between nominal value (what money looks like) and real value (what it can buy). For example, if you get a 2% raise in your salary but inflation is 3%, in real terms, you're actually losing purchasing power.
3. Long-term Commitments: If you're considering long-term commitments like mortgages or loans, understanding inflation can help you assess the real cost of those commitments in the future.
4. Protecting savings: If inflation is high, the money in your savings account might lose value over time, so you might be more inclined to invest it in assets that offer higher returns.
By understanding inflation, you can look for investment opportunities that protect against it. These include inflation-protected securities or assets that have historically risen with inflation, like real estate or certain commodities.
5. You know what you're talking about-you're not one of those talking heads. By understanding what is going on around you, you can help others to work through tough times or plan for the future. Plus, you'll look good at cocktail parties
On January 30, 2020, President Trump declared Coronavirus a public health emergency
Covid 19
The Covid-19 pandemic ushered in an unprecedented crisis which many governments had never seen before. With no prior experience on how to respond, most chose the obvious solution: total shutdown of the economy.
When businesses are shut down, people can no longer work and produce goods. This causes a shortage of products in the market, as demand exceeds supply.
The manufacturers then take advantage of the situation by raising their prices. They know that customers will be willing to pay a much higher price for goods since there is less available on the market now.
Seven months later, in August, I had a meeting with an old client of mine.
Every three years, he bought a new car. He came one year earlier this time
"But your car is only two years old," I reminded him.
He gave me a little smile and said, "That's true - but since the lockdown happened and I couldn't travel or go out like I used to, I had some extra money burning a hole in my pocket. So, I decided to buy a new car."
Normally, he would opt for the more affordable option - but this time he wanted the pricier model.
"Why?" I asked him. He chuckled and said, "It's not my money! Thanks to government stimulus checks, I'm going to treat myself!"
It was like a golden era for us, more customers than we could handle!
We were in a privileged position when it came to sales, as we had more people wishing to purchase cars than we had available for sale.
Since people had more money to spend and inventory was declining, prices rose.
The issue extends far beyond cars, as all products on the market have become increasingly pricey.
This was one of the driving forces behind prices rising across the board.
Impact on business and cost to consumer
It's no secret that businesses have costs. It takes a lot of money to create and bring products to market. From research and development, to marketing and shipping internationally, the price tag is often reflective of all the hard work it took for companies to get their goods in our hands.
So any change is affecting the final price
When I purchase an iPhone, the money is a revenue for Apple.
Part of that money goes to cover the cost of production and shipping, while the other part will go towards hiring new people for their research and development team. This allows them to design and produce better products with features I haven't even dreamed of - all these costs come together to determine how much I pay at the end.
If any of these costs increase, then it immediately affects the price I have to pay for the product.
Here's another example of a local boutique
Bella the owner of a small city boutique store faced this reality when the city announced its first lockdown.
Despite her closed doors, rent was still due every month. Bella had a loyal team and did her best to retain them by continuing to pay their salaries during the lockdown.
She then had to face with delays and premium prices when sourcing her unique clothing pieces from abroad. With the spring collections unable to be sold as summer approached, Bella had to allocate space for storage and sell them at deep discounts which affected her profit margins.
In order to stay afloat, Bella decided to pivot by setting up an online store. This required investing in a website, online payment gateways, and training her team to manage online orders. To promote her new store, Bella also invested in digital marketing and offered promotions and discounts to attract her loyal customers.
The cost of these investments inevitably gets passed on to the consumer.
That was the second reason for higher prices
Money Supply
The Federal Reserve (FED) is responsible for overseeing the economy, much like a watch dog.
To boost the economy and encourage people to spend more money in lockdown, the FED lowered interest rates and issued stimulus checks by printing additional funds. These actions made it possible for my client to purchase his car with a price tag that would otherwise have been out of his reach.
My friend was living in a rented apartment and it was nice but he didn't have any furniture yet.
When the stimulus checks came his way, he had some extra cash to buy furniture with.
But when he realized just how low the interest rates were, he told me "What the heck - I might as well take out a loan and get even more furniture!"
At the end of 2021 we stared to fell the pressure from the Covid and seems like we are recovering pretty fast until the Russian invasion to Ukraine happened
The Russian invasion of Ukraine
When Russia invaded Ukraine on February 23, it was a huge shock to many people.
Europe hadn't experienced war in over 100 years and the images of heavy artillery hitting Ukraine brought old memories back
In response to this invasion, Europe and its allies imposed sanctions on Russia.
The thing with sanctions is that they don't work immediately - it takes time for them to make an impact. This made me wonder how these sanctions will affect the rest of the world and each household.
Russia is a huge supplier of gas, oil, and wheat around the world. For example, Germany sources almost half of its gas for heating from Russia.
They're committing suicide, aren't they?
There was no doubt in my mind that Russia would counteract with high tariffs. As we've seen in the past, when the cost of materials rises, it's always the consumer who suffers.
Lets break down how Russian invasion affect the prices world wide
The war had a huge impact on energy and food markets, resulting in less supply and higher prices.
When I head out to the grocery store, I may not always think about it, but many of the goods I come across are imported from other countries. This is often due to companies being able to purchase these items more affordably elsewhere or because the country simply isn't producing that particular product.
Take Switzerland for example; bananas cannot be grown in this region, so they must be brought in from abroad.
Wheat
Wheat is an incredibly valuable crop that has a range of uses beyond providing the basis of our daily meals. From livestock feed to bioplastics and even beer production - wheat offers us so much more than we might think
For instance, did you know that wheat gluten can be converted into biofuel? Or that wheat germ oil can be used in cosmetics? Plus, wheat straw is even used in paper production – offering a sustainable alternative to wood pulp.
Wheat's versatility makes it an incredibly precious commodity.
How shortage of wheat drive prices?
A shortage of wheat or any product can increase prices by three main ways:
1. Supply and Demand: Reduced wheat supply with steady or increased demand pushes prices up.
2. Speculation: Anticipation of a shortage can lead traders to buy futures contracts, driving up prices.
3. Stockpiling: Countries or corporations might hoard wheat, exacerbating the shortage and price rise.
Heading back to the grocery store for my weekly shop.
Fertilizers
There's something that I'm sure many of us don't take into account - the cost of producing the food on our shelves. Take lettuce, for example. Every lettuce produced in the US uses some sort of fertilizer, and if the price of fertilizer increases, so does the price of the lettuce in my vegan hamburger.
They provide essential nutrients to help maintain healthy soil and maximize plant growth.
How the shortage of fertilizers increase prices?
1. Direct Impact on Crop Yields: A shortage means that crops might not get the necessary nutrients they need, leading to reduced yields.
2. Supply and Demand Dynamics: Crop yields drop, so agricultural products are less available. If demand remains constant or increases, prices for these products will rise due to the basic economic principle of supply and demand.
3. Increased Production Costs: As fertilizer prices increase due to shortages, farmers face higher production costs. In the absence of a solution, they will pass these increased costs on to consumers.
Oil and gas
Let's be real, when was the last time you bought something that said "made in Russia"? Yeah, I thought so. The Russian nation does have a lot going for them though - they're sitting on some of the world's best oil and gas reserves, as well as essential metals.
Europe has been relying on their imports of Russian gas and oil for decades, because it's one of the most cost-effective sources available. Germany alone used to buy almost half of their heating gas from Russia.
So when sanctions were imposed on Russian imports of oil and gas, it meant that there was a lot less supply coming into the market – resulting in higher prices for everyone else. It didn't stop there though - Russia also closed its airspace and land transportation, which had an impact on prices too.
Take me for example - when I order something from Aliexpress, the products are shipped from China using the airspace of Russia. When access was restricted it meant that airplains had to make a huge loop in order to complete their deliveries – meaning more fuel spent, resulting in higher prices for me on the USB cable I ordered to save a few bucks.
The sanctions didn't just affect air travel, either – they impacted shipping from other countries in the region too. Russian railways used to be a big shipping option for EU countries, but they had to find another solution when that option was cut off - which raised prices.
How the shortage of Oil and gas increase prices?
1. **Global Connection:** Even if the U.S. doesn't buy a lot of oil and gas from Russia, what happens in one part of the world can affect prices everywhere. When Russia couldn't sell as much oil and gas because of sanctions, there was less available for everyone, making prices go up.
2. **Expectations of the Future:** Traders try to predict how oil and gas prices will change. As soon as they knew there would be a shortage, they bought more oil, which actually pushed prices up.
1. **U.S. Oil Reserves:** The U.S. has a backup supply of oil. To help with high prices, the U.S. has used its backups. They'll want to fill it up again later, which could affect prices.
Trade offs/sacrifices
There is a lot of advice you can find online: make a budget, freeze your credit card, use coupons when shopping, and plan ahead. But there's an even better way to manage your finances.
But there is a better way.
Let me explain.
The world that we live in has finite resources, and understanding how to make the most of them is key.
That's where trade-offs come into play.
It's like I have my own personal piggy bank with all the money I've saved up from my allowance, birthday gifts, and doing some chores.
The money in this little guy is limited so if I want to buy something fun, it means sacrificing something else.
Definition of trade-offs
"Trade-offs" means that when you choose to do one thing, you often have to give up the chance to do something else. It's like when you have to decide between two things you want but can only pick one.
Let's go back to the piggy bank example. Lets say you have $20 in it. You really want a new video game that costs $30, but you also want to go to the movies with your friends this weekend, and that will cost $15.
Here's where the trade-off comes in: If you spend $15 on the movie, you'll only have $5 left, which means you'll be even further away from getting that $30 video game.
When our financial resources are stretched thin and wages remain stagnant, the concept of trade-offs can be a powerful tool to help us make smart decisions.
But trade offs are not limited only to money.
My story
I also faced a similar situation when deciding which career move to make.
I wanted to work at the dealership, which paid more than my current job, however it was located in a different area. This meant I would need to give up some of the things that made my life easier such as my morning workouts and writing my newsletter in the mornings. I would also need to spend two hours traveling to work instead of just 20 minutes!
Eventually, I decided it wasn't worth giving up all these other things for the extra money.
It's impossible to make the final decision without sacrificing something
Buying a Car
Recently, one of my clients came in and said that he wanted a sporty car. No problem I said and rushed to show him the GOLF GTI. As I was moving towards the car, he also noted that he wanted something fuel efficient and low maintenance.
I was confused.
You can't have them both I replied.
My client was facing a dilemma and he needed to choose between two choices.
Hybrid: Saves money on gas, good for the environment and lower maintainces.
Sports Car: Fast and stylish, but uses more gas and can be expensive to maintain.
He made the final choice but for him it was a difficult one.
This is why I said it's impossible to make the final decision without sacrificing something.
This realization came to me as I was writing.
That's because there's a lot of choice today in every product, service, relationship, and opportunity.
However, we only need to pick one
5 examples from daily life
Here are five examples from daily life where the concept of the Pareto front can be applied to decision-making:
Diet and Taste
Trade-off: Healthier foods might not always be the tastiest. For example, a salad might be more nutritious than a burger, but many might prefer the taste of the burger.
Study Time and Leisure
Trade-off: Spending more time studying for an exam might lead to better grades, but it reduces leisure time.
Saving and Spending
Trade-off: Spending more money on a vacation or shopping might bring immediate joy, but it reduces potential savings.
Exercise Intensity and Recovery
Trade-off: Intense workouts might lead to better fitness results but require longer recovery times.
Work Hours and Family Time
Trade-off: Working longer hours might lead to a higher income but reduces time spent with family.
Simple solution
To make things easier and faster I made a video showing how to use ChatGPT to make buying decisions.
Here is the link with captions
If you enjoy listening me but dont want to see me here is a link to the audio version
Here is the prompt
I'm a [ student/professional] and I'll be using this [product/serivce] for [usage] .
My main priority is [your top priority]
Which [product] should I buy?
Top 5 General Criteria for Buying Any Product
1. Performance: Evaluate how well the product does what it's supposed to do. This could involve speed, efficiency, or the quality of output.
2. Usability: Consider how easy it is to use the product. This includes the user interface, accessibility features, and overall user experience.
3. Design: Look at the aesthetic and ergonomic aspects. A well-designed product is not only pleasing to the eye but also comfortable and intuitive to use.
4. Durability: Assess the build quality and longevity. A durable product will offer better value for money in the long run.
5. Value for Money: Compare the product's price with its features, performance, and durability to determine if it offers good value for the price.
Summery
For me, this is just the start of my journey. My goal is to explore the psychology behind our purchasing decisions. There is so much to learn about how we view money, how we perceive risk, and how we make choices when there is uncertainty about the future. It will be an intriguing ride, and I invite you to join me. Each week, I will be sharing insights on how to navigate the increasing costs of living.
Nikita