Merry Christmas, The Government Is Giving You Inflation (Or Why You’re Actually Paying $5.28/Gallon of Gas)

Gas_prices

It’s not every day that the mainstream news is so helpful in fully illustrating an economic principle, but then again maybe that’s their Christmas present to us.  This Associated Press story: http://www.usatoday.com/money/industries/energy/2010-12-23-gasoline-oil-prices_N.htm, among other important details, has the following paragraph in it:

“The PortiaGroup-OSIP study says gas pump prices are taking a bigger bite out of household spending: an average 7.4% of median household income compared with 6.5% last year and 4.2% in 2008. If the pattern of higher oil prices persists, the average share of income spent on gasoline could rise to almost 10% by spring, with pump prices around $3.75 or more a gallon.”

This is the very definition of inflation.  For those of you that don’t know that it’s occurring in this country, this is a perfect example.  Let’s look at this: gas prices are getting higher.  That’s part of inflation, but the most important thing to note is that the percent of household income being spent on gasonline is increasing significantly while prices are not as high as they have in the past.

For instance, in 2008, gas reached as high as $4 per gallon.  It’s at $3 as of this morning, but yet that represents 7.4% of household income versus 4.2% in 2008.  Gas prices are cheaper than 2008 yet represent almost a doubling in the percentage of household income spent on it!  That means that people are spending MORE of their money on CHEAPER gas.

The obvious response to this would be that people might be spending more money as a percentage on things like gasoline because they have less household income.  This is quite likely true.  However, there are two factors that point to this being more than a reduction in income.  The first is that incomes would have been more drastically lowered in 2008 as we were going into the “Great Recession”, since that was the start of the problem and not the “end” as we are supposedly experiencing now.  (The story above the one I read in this morning’s Tampa Tribune mentioned how the “economy brightens”, so things should at least be starting to ‘pick up’ if that’s true.)  The second factor is that in order for the percentage to have gone from 4.2% of household income for $4 gas to 7.4% of $3 gas, income would have had to have fallen a drastic amount.  Here’s an example.

In 2008, if a person makes $50,000 a year, spending 4.2% of household income on gas would mean a spending of $2,100 a year.  Dividing that by $4 a gallon means a purchase of 525 gallons of gas over the year.

In 2010, if a person makes $50,000 a year, spending 4.2% of household income on gas would mean a spending of $2,100 a year.  Dividing that by $3 a gallon means a purchase of 700 gallons of gas over the year.

However, in 2010, people are spending 7.4% of household income on gas.  Let’s look at the numbers now:

In 2008, if a person makes $50,000 a year, spending 4.2% of household income on gas would mean a spending of $2,100 a year.  Dividing that by $4 a gallon means a purchase of 525 gallons of gas over the year.

In 2010, if a person makes $50,000 a year, spending 7.4% of household income on gas would mean a spending of $3,700 a year.  Dividing that by $3 a gallon means a purchase of 1,233 gallons of gas over the year.  (They spent a lot more money, so they get a lot more gas.)

What these numbers would mean automatically is that people should have more than doubled the amount of driving they do if they almost double the amount of gas they buy and gas got cheaper.  Do you know anyone who has doubled their driving recently?

Wait, what about reduced incomes?

Let’s look at those numbers:

In 2008, if a person makes $50,000 a year, spending 4.2% of household income on gas would mean a spending of $2,100 a year.  Dividing that by $4 a gallon means a purchase of 525 gallons of gas over the year.

In 2008, if a person makes $45,000 a year, spending 4.2% of household income on gas would mean a spending of $1,890 a year.  Dividing that by $4 a gallon means a purchase of 472.5 gallons of gas over the year.  (This makes sense; with less income, spending the same percentage means they buy less gas.)

In 2010, if a person makes $45,000 a year, spending 4.2% of household income on gas would mean a spending of $1,890 a year.  Dividing that by $3 a gallon means a purchase of 630 gallons of gas over the year.  (This makes sense also; with less income, but 25% cheaper gasoline, they get more gas.)

In 2010, if a person makes $45,000 a year, spending 7.4% of household income on gas would mean a spending of $3,330 a year.  Dividing that by $3 a gallon means a purchase of 1110 gallons of gas over the year.  (This makes sense – the gas is cheaper and they’re spending a lot more money, so they get a lot more gas.)

So even with an income reduction of 10%, the person in 2010 should be able to do slightly more driving if they are still only spending 4.2% of their income on gasoline.  However, by spending 7.4% of their income on gasoline, even with a reduced income, they should be able to more than double their driving.

Do you know anyone who is doing MORE driving?

Of course you don’t.  That’s because the value of the dollar is falling, caused by inflation.  When the government prints money (as they and the Fed are wont to do), the value of each dollar decreases.  People who make $45,000 in 2010 aren’t getting 1110 gallons over the course of the year.  What you could buy in 2008 for $45,000 cost $46,200 in 2009 (using nominal GDP measures: http://www.measuringworth.com/uscompare/).  That means that at the very least, there was 3% inflation.  Most people accept that there will be 3% inflation per year – and plan for it.  However, the real inflation rate, as illustrated by the numbers above, would be:

In 2008, if a person makes $50,000 a year, spending 4.2% of household income on gas would mean a spending of $2,100 a year.  Dividing that by $3 a gallon means a purchase of 700 gallons of gas over the year.

In 2010, if a person makes $50,000 a year, spending 4.2% of household income on gas would mean a spending of $2,100 a year.  Dividing that by $3 a gallon means a purchase of 700 gallons of gas over the year.

In 2010, if a person makes $50,000 a year, spending 7.4% of household income on gas would mean a spending of $3,700 a year.  Dividing that by $3 a gallon means a purchase of 1,233 gallons of gas over the year.

That means that if the dollar values had stayed uninflated, then this fictional purchaser could have gotten a lot more gas.  However, if we assume their driving patterns stay the same (that they only got 700 gallons of gas), then they paid $5.28 in 2008 dollars for a gallon of gas ($3,700 spent divided by 700 gallons).  That means that their gallon of gas in 2010 actually costs 132% more!!  (($5.28/$4)*100)

Of course, when government reports inflation numbers, it excludes energy numbers such as those for gasonline.  If you’ve ever wondered why that is, it’s due to the fact that most people can see that they’re spending so much more money to get so much less energy, and reporting energy costs clearly shows that there is inflation.

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