What it is:
How it works/Example:
For example, let's say John Doe works for Company XYZ. His salary is $100,000 per year. He started the job five years ago at $100,000 and has not had a raise since he took the job.
If the inflation rate is 3% per year, then the value of that $100,000 falls by 3% a year as goods and services get more expensive. As a result, after the first year on the job, John's salary is really able to buy only $97,000 of goods and services [$100,000 - (3% x $100,000) = $97,000]. In year two, John's salary is then worth only $94,090 [$97,000 - (3% x $97,000) = $94,090]. The longer this goes on, the less John's $100,000 salary buys. By the end of five years, John's salary would be "worth" only $85,873.