Bitesized Money

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Inflation means that the things you buy were cheaper yesterday than they are today.

Prices for everything, such as food, clothes, cars and holidays tend to go up year after year. This is called Inflation. If something was cheaper yesterday than it is today, then this is Inflation. The amount they go up by over a year is the Inflation Rate. So if your favourite breakfast cereal is 10% more expensive today than it was this time last year, then the Inflation Rate is 10%.

So to understand what causes inflation let's look at my neighbour Suzy’s Lemonade Stand again.

Suzy makes excellent Lemonade and that is because she buys amazing lemons from Leroy, our local lemon farmer. For months Suzy has paid Leroy £5 for a bucket of lemons each day.

Leroy has a bit of a problem though. Everybody wants his lemons, but there is a big shortage of skilled Lemon pickers. To get the people he needs he must start offering higher pay. To find the extra money to cover these costs he decides to raise his prices and charge Suzy £6 for a bucket of lemons instead.

Now Suzy has a problem, this increase in lemon costs will mean she won’t make any profit selling her Lemonade, so she decides to increase the cost of her delicious drinks by 50p per cup.

So now all of Suzy’s Lemonade drinking customers must pay an extra 50p per day to get their Lemon fix. They can’t afford this so they all go and ask their bosses for a pay rise, meaning those companies will need to raise their prices! And so it continues.

This is just one example, and lots of things can cause inflation. Oil and Gas prices increasing due to shortages are having a big impact as I write this for example.

Some inflation is good as it encourages people to spend money (“I will buy the car today as it will be more expensive next year!”), which keeps businesses going and people employed. If inflation is too high or too low it can cause big problems. In general the Government tries to keep the Inflation Rate at 2%.

A Dividend is simply a profit share.

If you own Shares in a company, and the company is profitable, typically once a year they will transfer some money into your account, this is called a Dividend. This Dividend is your share of the company’s profits, and you can withdraw and spend it however you wish.

Let’s imagine your neighbour Suzy wants to open a Lemonade Stand. She needs some investment to buy lemons, so being a shrewd investor, you offer to give her £100 in exchange for half her company (the Shares) and half of any profit she makes (the Dividend). Suzy has a busy week and sells lots of Lemonade, after buying enough Lemons for next week she is left with £20 of profit. She gives you £10 (the Dividend) and she keeps the other £10. You still own half her company, and you will keep receiving half of the profits every week.

In large companies the Directors may decide not to pay all their profits in Dividends, instead choosing to reinvest to buy new machinery, or grow the business. But in the next article we will discuss Dividend Yield which helps you compare which companies pay the best Dividends.