Inflation and purchasing power
Inflation is a general rise in prices over time. It is measured as a percentage per year, for example with the Consumer Price Index (CPI).
Purchasing power is how much a sum of money can buy. When prices rise, purchasing power falls.
Worked example
A notebook costs ₹50. With 10% inflation, next year it costs 50 + 10% of 50 = ₹55. With ₹550 you could buy 11 notebooks this year but only 10 next year.
Real return
If a bank pays 7% interest and inflation is 5%, your real return is about 7 − 5 = 2%. If inflation is higher than the interest rate, your money's real value shrinks.
Simple vs compound interest
Principal (P) is the money you deposit or borrow; rate (R) is the percent per year; time (T) is in years.
Simple interest (SI)
Interest only on the original principal.
SI = P × R × T ÷ 100; Amount = P + SI.
Example: ₹1,000 at 10% for 3 years: SI = 1,000 × 10 × 3 ÷ 100 = ₹300; Amount = ₹1,300.
Compound interest (CI)
Interest is added to the principal each year, and next year's interest is on the bigger amount.
A = P × (1 + R/100)T; CI = A − P.
Example: ₹1,000 at 10% for 3 years: Year 1: 1,000 → 1,100; Year 2: 1,100 → 1,210; Year 3: 1,210 → 1,331. CI = ₹331, which is ₹31 more than SI.
Rule of 72: money roughly doubles in 72 ÷ R years with compounding (at 8%, about 9 years). Compounding helps savers, but on loans and credit-card dues it works against you.
Budgeting
A budget is a plan of expected income and spending for a period, such as a month.
- Write down all income.
- List needs (food, rent, school fees, transport) and wants (outings, new gadgets).
- Save first: set aside savings as soon as income comes.
- Track spending and compare with the plan at the end of the month.
50-30-20 rule: about 50% needs, 30% wants, 20% savings. It is a guide, not a law; a poorer family may need more for needs.
Budgets can be surplus (income more than spending), balanced (equal) or deficit (spending more than income, which needs borrowing).
Also keep an emergency fund of a few months' expenses.
Savings, investments, risk and insurance
Savings vs investments
Saving is keeping aside part of income, usually in a safe place like a savings account. Investing is putting money into assets that can grow, like fixed deposits, PPF, gold, bonds, mutual funds or shares.
Risk and return
| Option | Risk | Usual return |
|---|---|---|
| Savings account | Very low | Low |
| Fixed deposit, PPF, post office schemes | Low | Moderate, fixed |
| Gold, government bonds | Low to medium | Varies |
| Mutual funds | Medium to high | Can be higher, not fixed |
| Shares | High | Can be high, can also be a loss |
Diversification: do not put all eggs in one basket. Beware of schemes that promise very high, sure returns; they are often frauds.
Insurance
Insurance protects against big, uncertain losses. You pay a small, regular premium. If the insured event happens, the company pays a claim. It works because many people pay in, but only a few suffer the loss in a year. Types: health, life (term), vehicle, crop (e.g. the government's crop insurance scheme) and home insurance.
Personal income tax
Income tax is a direct tax paid to the Union government on a person's yearly income. It pays for roads, defence, schools and hospitals.
- India uses slabs: income is split into parts, and each part is taxed at its own rate. Rates rise as income rises (a progressive tax).
- The year for which income is counted is the financial year (1 April to 31 March). A return (ITR) is filed after it ends.
- Every taxpayer has a PAN (Permanent Account Number).
Example using the new regime slabs announced in Budget 2025 (check the current year's rules)
Slabs on taxable income: up to ₹4 lakh nil; ₹4–8 lakh 5%; ₹8–12 lakh 10%; ₹12–16 lakh 15%; ₹16–20 lakh 20%; ₹20–24 lakh 25%; above ₹24 lakh 30%. A rebate makes tax zero for taxable income up to ₹12 lakh, and salaried people get a standard deduction of ₹75,000. A 4% health and education cess is added.
Taxable income ₹14,00,000: 4 lakh × 5% = ₹20,000; next 4 lakh × 10% = ₹40,000; last 2 lakh × 15% = ₹30,000. Total ₹90,000 + 4% cess ₹3,600 = ₹93,600.
Try it at home
Keep a spending diary for one week: write every rupee you or your family spend on small items. Mark each as need or want. Next week, set a 20% savings target first and see if you can stay within the rest. Also compare today's price of milk or petrol with a bill from a few years ago to feel inflation.
Key formulas and definitions
- SI = P × R × T ÷ 100; Amount = P + SI.
- Compound amount A = P × (1 + R/100)^T; CI = A − P.
- Real return ≈ interest rate − inflation rate.
- New price = old price × (1 + inflation/100).
- Rule of 72: years to double ≈ 72 ÷ R.
- Budget rule of thumb: 50% needs, 30% wants, 20% savings.
- Higher possible return ⇒ higher risk.
- Income tax: progressive slabs on taxable income, plus 4% cess.
Worked examples
1. Rice costs ₹60 per kg. Inflation is 5% a year. What will it cost after 1 year and after 2 years (compounded)?
After 1 year: 60 × 1.05 = ₹63. After 2 years: 63 × 1.05 = ₹66.15.
2. Find the simple interest on ₹5,000 at 6% per year for 4 years.
SI = 5,000 × 6 × 4 ÷ 100 = ₹1,200. Amount = 5,000 + 1,200 = ₹6,200.
3. Find the compound interest on ₹5,000 at 10% per year for 2 years.
Year 1: 5,000 + 500 = 5,500. Year 2: 5,500 + 550 = 6,050. CI = 6,050 − 5,000 = ₹1,050. (SI would be ₹1,000.)
4. A bank pays 6% interest and inflation is 8%. Is the saver gaining or losing buying power?
Real return ≈ 6 − 8 = −2%. The saver is losing about 2% of buying power each year.
5. Sunita's family earns ₹30,000 a month. Make a 50-30-20 budget.
Needs 50% = ₹15,000; wants 30% = ₹9,000; savings 20% = ₹6,000. Savings are set aside first.
6. Using the Rule of 72, how long will money take to double at 9% compound interest?
72 ÷ 9 = about 8 years.
7. 1,000 families each pay ₹2,000 a year for health insurance. If 10 families need ₹1,50,000 each for treatment, can the pool pay?
Pool = 1,000 × 2,000 = ₹20,00,000. Claims = 10 × 1,50,000 = ₹15,00,000. Yes, the pool can pay, with ₹5,00,000 left for costs and reserves.
8. Using the slabs above, find the tax on a taxable income of ₹10,00,000.
Taxable income is up to ₹12 lakh, so the rebate makes the tax zero. (Without the rebate it would be 4 lakh × 5% + 2 lakh × 10% = ₹40,000.)
Common mistakes
- Using the SI formula for compound interest questions. For CI, interest is added each year.
- Thinking money in a locker keeps its value. Inflation reduces its purchasing power.
- Thinking the highest return is always best. Higher return comes with higher risk.
- Taxing the whole income at the top slab rate. Each slab part is taxed at its own rate.