Economic Engineering - Inflation - Lectures 1&2

Lectures in Engineering Economy
Prof. Corrado lo Storto

DIEG, Dept. of Economics and Engineering Management
School of Engineering, University of Naples Federico II
email: corrado.lostorto@unina.it
phone: 081-768.2932
Major issues
 What is inflation?
 How do we measure inflation?
 How we can deal with inflation in engineering economic studies, i.e.
how do we incorporate the effect of inflation in equivalence
calculation?
Engineering Economy/inflation/ 2005 /prof. corrado lo storto

Inflation and price change
Technically, inflation is the phenomenon of (continuously) rising prices

bringing about as a result a decline over time of the purchasing power of
a given unit of money.
Inflation is worrisome for economy, but tend to be inevitable.
It is a fact of life and can significantly affect the economic comparison of

alternatives.

Purchasing Power: inflation
$100 $100
1990 1990 2003

You could buy 50 Big Macs in You can only buy 40 Big Macs
year 1990. in year 2003.
25%
$2.00 / unit $2.50 / unit
Price
change due
to inflation
The $100 in year 2003 has only $80
worth purchasing power of 1990

Purchasing Power: deflation
$100 $100
-2 -1 0 1 -2 -1 0 1
You could purchase 63.69 You can now purchase 80

gallons of unleaded gas gallons of unleaded gas.
a year ago.
20.38%
$1.57 / gallon $1.25 / gallon
Price change due to
deflation

All-Time Top 10 Movies

Practice Problem - How to Compare the Winning Prizes in
Two Different Points in Time Dollars
1963 2004
Jack Nicklaus won his first Master Phil Mickelson won his first
Tournament in 1963. The prize Master Tournament in 2004.
was $20,000. The prize amount was $1.17M.

What is the worth of $1.17M in terms of purchasing
power in 1963?
The average inflation rate between 1963 and 2004 is

about 4.53% per year.
$1.17M in 2004 would have a purchasing power of $190,616

in 1963

What is the worth of $1.17M in terms of purchasing
power in 1963?
If Jack invested his prize money in 1963 at 5.65% (inflation-free interest

rate), the prize money would grow to match Phil’s 2004 prize.
$20,000
0
1963 $190,616
P  $190, 616(P / F , 5.65%, 41)

 $20, 000
41
0
2004
1963

Inflation measurement
A price index is usually calculated to measure historical price level changes

for a particular good or the general cost of living.
A price index is the ratio of the historical price of some commodity or

service at some point in time to the price at some earlier point.
The earlier point in time is usually selected as a base year. The price index
in question and other indexes are therefore related to the same base.

Measuring Inflation
Consumer Price Index (CPI): the CPI compares the cost of a sample
“market basket” of goods and services in a specific period relative to the
cost of the same “market basket” in an earlier reference period. This
reference period is designated as the base period.
Market basket
Base Period (1982-84) 2002
$100 $179.9
CPI for 2002 = 179.9

Inflation measurement: an example
base year: 1967  price index 1967=100
commodity price 1967 = $1.46/lb

commodity price 2001 = $6.37/lb
then
$ 6.37/lb
price index 2001  100   436.3
$ 1.46/lb

Computing the inflation rate f
The historical annual rate of price increase can be computed from any of
the several available indexes.
Using the CPI values, the annual inflation rate can be calculated as
CPIt+1  CPt
annual inflation rate for year t+1 =
CPt
where CPIt is the index of consumer prices
Most economic studies require the use of estimates that depend on

expectations of future inflation rates. The determination of these rates
should be based on trends of historical rates, predicted economic
conditions, judgment, etc. The accurate prediction of future inflation
rates is a difficult endeavour.

Estimating rate f from CPI Data
Year CPI
1986 328.4
1987 340.4
1988 354.3
1989 371.4
1990 391.4
Example 1: Average inflation rate Example 2: Average inflation

for 1990 rate using CPI data for 1987 to
1990:
CPI(1990)  CPI(1989)
f  CPI(1990)=CPI(1987)×(1+f)3 
CPI(1989)
391.4  371.3 391.4
  5.4% f  3  1  4.76%
371.3 340.4

Inflation rate
Annual rates of inflation vary widely for different types of goods and
services and over different periods of time.
Rates of inflation also vary for different countries in the same period of
time.

Factors affecting inflation rate
Several factors in the economy push prices for goods and services
upward or downward:
- an increase in productivity of production
processes
tend to reduce prices
- an increase in the availability of goods
- government policies (i.e., price supports,

tend to increase prices
deficit financing, etc.)
The combined cumulative effect of all these factors determine the amount
of price change.

CPI measurement: an example
year CPI Rate % year CPI Rate % year CPI Rate %

1965 94,5 1,7% 1977 181,5 6,5% 1989 371,3 4,8%
1966 97,2 2,9% 1978 195,4 7,7% 1990 391,4 5,4%
1967 100,0 2,9% 1979 217,4 11,3% 1991 408,0 4,2%
1968 104,2 4,2% 1980 246,8 13,5% 1992 420,3 3,0%
1969 109,8 5,4% 1981 272,4 10,4% 1993 432,7 3,0%
1970 116,3 5,9% 1982 289,1 6,1% 1994 444,0 2,6%
1971 121,3 4,3% 1983 298,4 3,2% 1995 456,5 2,8%
1972 125,3 3,3% 1984 311,1 4,3% 1996 469,9 2,9%
1973 133,1 6,2% 1985 322,2 3,6% 1997 480,8 2,3%
1974 147,7 11,0% 1986 328,4 1,9% 1998 488,3 1,6%
1975 161,2 9,1% 1987 340,4 3,7% 1999 497,6 1,9%
1976 170,5 5,8% 1988 354,3 4,1% 2000 509,0 2,3%

Consumer Price Index
91.7 100 561.23
1963 2004
1967
Average inflation rate = 4.525%

CPI trend in USA from 1965 to 2000
600
500
400
CPI (%)
300
200
100
0
1965 1970 1975 1980 1985 1990 1995 2000
year

The CPI, the PPI, and the IPI indexes
It is possible to prepare price indexes not only for the individual

goods/commodities or classes of products, but also composite indexes.
These composite indexes include the Consumer Price Index (CPI), the
Producer Price Index (PPI), and the Implicit Price Index for the Gross
National Product (IPI-GNP).

Selected Price Indexes

Inflation rate in USA from 1965 to 2000
16%
14%
annual inflation rate (%)
12%
10%
8%
6%
4%
2%
0%
1965 1970 1975 1980 1985 1990 1995 2000
year

Actual money versus real money
According to definition, inflation describes the situation in which prices of

fixed amounts of goods and services are increasing.
And as prices rise, the value of money – its purchasing power – decreases
correspondingly.
Two kinds of money units can be defined:
 actual money units
 real or constant money units

Actual and real money units
 actual money units (i.e., actual Euros, Dollars): the actual number of
money units as of the point in time they occur and the usual kind of
money units in which people use to think. They are also called the
current money units (or, the inflated money units). It can be denoted
as “A€” if we adopt, for instance, Euros as money units;
 real money units (i.e., real Euros, Dollars): money units of purchasing
power as of some base point in time, regardless of the point in time
the actual money units occur. They are also called constant money
units, or constant worth money units, or even uninflated money
units. It can be denoted as “R€” if for instance Euros are adopted as
money units. If the base point in time, k, needs to be specified – that
is the time of the study or the initial investment – it can be shown
with a superscript, i.e. R€(k)

Actual and real money units
At any time n actual money units can be converted into real money units
at time n of purchasing power as of any base time k:
nk
 1 
R£n(k)  A£n    A£n (P / F, f%,n  k)
1  f 
A£n  R£(k ) 1  f 
nk
 R£n(k ) (F / P, f%,n  k)
where f is the average inflation rate per period over the n-k periods

Conversion from Constant to Actual Dollars
_ _
n
An  A 'n (1  f )  A 'n (F / P , f , n )
n3 $1,260
$1,000 _
f  8%
3
3
Actual
Constant
3 Dollars
Dollars $1,000 (1 + 0.08)
= $1,260

Example: conversion from Constant to Actual Dollars
Net Cash Flow in Conversion Cash Flow in

Period
Constant $ Factor Actual $
0 -$250,000 (1+0.05)0 -$250,000
1 100,000 (1+0.05)1 105,000
2 110,000 (1+0.05)2 121,275
3 120,000 (1+0.05)3 138,915
4 130,000 (1+0.05)4 158,016
5 120,000 (1+0.05)5 153,154

Example: conversion from Constant to Actual Dollars
$120,000 $130,000
$110,000
$100,000 $120,000
0
1 2 3 4 5
Years
$130,000(1+0.05)4
$120,000(1+0.05)5
(a) Constant dollars
$100,000(1+0.05)
$120,000(1+0.05)3
$110,000(1+0.05)2
$250,000
$250,000(1+0.05)0
$138,915 $158,016
$121,275
$105,000 $153,154
0
1 2 3 4 5
Years
(b) Actual dollars
$250,000 Engineering Economy/inflation/ 2005 /prof. corrado lo storto
Conversion from Actual to Constant Dollars
_ _
n
A 'n  An (1  f )  An (P / F , f , n )
n3 $1,260
$1,000 _
f  8%
3
3
Actual
Constant -3
$1,260 (1 + 0.08) Dollars
Dollars
= $1,000

Example: conversion from Actual to Constant Dollars
Loss in
End of Cash Flow in Conversion Cash Flow in
Purchasing
period Actual $ at f = 5% Constant $
Power
0 -$20,000 (1+0.05)0 -$20,000 0%
1 20,000 (1+0.05)-1 -19,048 4.76
2 20,000 (1+0.05)-2 -18,141 9.30
3 20,000 (1+0.05)-3 -17,277 13.62
4 20,000 (1+0.05)-4 -16,454 17.73

The average annual inflation rate
Many studies use an average annual inflation rate when the projected
life of the investment is long.
This approach requires the estimate of a single average rate that

represents a composite of the individual yearly rates.

Average Inflation Rate (f)
Fact:
Base Price = $100 (year 0)
Inflation rate (year 1) = 4%
Inflation rate (year 2) = 8%
Average inflation rate over 2 years?
Step 1: Find the actual inflated price at the end of year 2.

$100 ( 1 + 0.04) ( 1 + 0.08) = $112.32
Step 2: Find the average inflation rate by solving the

following equivalence equation.
$112.32
$100 ( 1+ f) = $112.32
f = 5.98% 0 1
2
$100

Example: The average annual inflation rate and
inflation effects
The average inflation rate in USA, f, from the end of 1966 to
the end of 1980 (14 years) can be calculated as
97.2 1  f   246.8 f=6.9% per year

14
From the end of 1989 through 1998 (9 years) the average inflation rate
was
371.3 1  f   488.3
9
f=3.1% per year
As a general expression,
CPIt 1  f   CPIt+n
n
The concept of the average annual inflation rate facilitates inflation

calculations. In most instances, the estimation of individual yearly
inflation rates is time consuming and using these rates usually is no
more accurate than using a single composite rate.
Example: Average Inflation Rate
Item 2003 Price 2000 Average Inflation

Price Rate (%)
Consumer price index (CPI) $184.20 $171.20 2.47
Postage 0.37 0.33 6.44
Homeowners Insurance 603.00 500.00 7.56
Private college tuition and fees 18,273 15,518 5.60
Gasoline 1.65 1.56 1.89
Haircut 12.00 10.50 4.55
Car (Toyota Camry) 22,000 21,000 1.56
Natural gas (MBTU) 5.67 3.17 21.38
Baseball tickets 148.66 132.44 3.92
Cable TV 47.97 36.97 9.07

General Inflation Rate (f)
Average inflation rate based on the CPI
_
CPI n  CPI 0 (1  f )n ,
1/ n
_ CPI n 
f   1
 CPI 0 
_
where f  The general inflation rate,
CPI n  The consumer price index at the end period n ,
CPI 0  The consumer price index for the base period.

Example: Yearly and Average Inflation Rates
Year Cost
What are the annual inflation rates
0 $504,000 and the average inflation rate over 3 years?
1 538,000
2 577,000
3 629,500
Solution
Inflation rate during year 1 (f1):
($538,400 - $504,000) / $504,000 = 6.83%.
($577,000 - $538,400) / $538,400 = 7.17 %.
($629,500 - $577,000) / $577,000 = 9.10%.
The average inflation rate over 3 years is
$629,500 1/ 3
f ( )  1  0.0769  7.69%
$504,000
Exercise 1: The average annual inflation rate
Suppose Mr Smith can invest $ 100 at the present time with the
expectations to earn 15% annually for the next 5 years. At the present
Mr Smith can purchase one automobile tire for $ 100, but suppose that
these tires are increasing in price at an annual rate of 10%. What Mr
Smith will decide?

Solution to exercise 1
At the end of 5 years the accumulated amount will be
F = $100 1 + 0.15  = $201.10

5
At the end of 5 years the same tire will cost
F = $100 1 + 0.10  = $161.10

5
Under these conditions, Mr Smith would be misled if he ignored the

change in prices. He would then have the erroneous impression that if he
invested now, the money to purchase two tires would be available at the
end of five years. Actually, the money he would receive from the
investment would purchase only 1.25 tires.

Inflation and engineering economic studies
 If all cash flows in an economic comparison of alternatives are

inflating at the same rate, inflation can be disregarded in before-tax
studies.
 Vice versa, when all incomes and all expenses are not inflating at the
same rate, inflation gives rise to differences in economic attractiveness
among alternatives. In this case it should be taken into account.
 Not including the effects of inflation in an engineering economy study,

leads to an erroneous choice among competing alternatives.
Henceforth, by assuming that inflation affects all investment
opportunities to the same extent may lead to reversal in preference,
and compromise the objective to maximize shareholders’wealth.

Real interest rate, combined interest rate, and inflation
rate
We define several types of rates:
 Real interest rate: it is the increase in real purchasing power
expressed as a percent per period, or the interest rate at which
RMU outflow is equivalent to RMU inflow. It is also called real
monetary rate or uninflated rate and is denoted as ir
 Combined interest rate: it is the increase in dollar amount necessary
to cover real interest and inflation expressed as a percent per
period. It is the interest rate at which AMU outflow is equivalent to
AMU inflow. It is also called as actual rate or inflated rate and is
denoted as ic
 Inflation rate: it is defined the increase in price of given goods or
services as a percent per time period. It is denoted as f. The overall
rate for an individual or organizations is sometimes called the
general inflation rate.

Inflation-Free Interest Rate i
 Represents only earning power of capital
 Ideal market rates when there is no inflation
 All rates you have used till now are inflation-free
 Also called real-, or constant-money interest rate

Market Interest Rate ic
 Includes combined effects of:
• earning power of capital
• expected inflation
 Examples:
• rates stated by financial institutions (loans, bank accounts,

bond and stock returns)
• MARR set by firms
 Also called composite, or inflation-adjusted

Real interest rate, combined interest rate, and inflation
rate
The real interest rate and the inflation rate have a multiplicative or
compounding effect.
ic  1  ir 1  f   1
ic  ir  f  ir  f 
Also,
ic  f
ir 
1 f
In the case f is not large relative to the desired accuracy, then

ic  ir  f
and
ir  ic  f
What interest rate to use in engineering economy studies?
The interest rate which is appropriate for time-value calculation in
engineering economy studies depends on the type of cash flow estimates:
If cash flows are Then the interest rate

method
estimated in terms of to use is
Combined interest
A Actual MU, AMU
rate, ic
Real MU, RMU
B Real interest rate, ir
The above is made intuitively consistent if one thinks in terms of

method A as working with inflated (actual) monetary units (i.e., Euros)
and interest. Method A is the most natural to use because we usually
think in terms of AMU. Since interest paid or earned is based on AMU, it
is a combined interest rate ic.
However, method B is sometimes easier to use.

Examples: Market vs. Inflation-Free Interest Rates
• f : average inflation rate Example: inflation rate 6%,

• i : inflation-free rate interest rate 12%
• ic : market interest rate ic  (1.12)(1.06)  1  18.72%
ic  (1  i)(1  f)  1
Example: inflation rate 6%,
Formula holds for effective interest rate 12% compounded
interest rates monthly
Nominal rates must first be
converted to effective  r 
12
 .12 
12
ic  1    1  1    1  12.7%
 12   12 
ic  (1.127)(1.06)  1  19.46%

Consistency in Economic Evaluations
 Consistent use of cash flows and interest rates
 Cash flows in actual dollars must be discounted at market interest

rates (inflation-adjusted)
 Cash flows in constant dollars must be discounted at inflation-free

interest rates

Example: Project P has initial cost  Wrong Solution:

of $2000 and produces net benefit Use constant $ with inflation-
of $850/yr in real dollars for 3 yrs. adjusted MARR
MARR=15%, which incorporates Year
CF
(real $)
estimated inflation rate of 5%. 0 -2000.00
Should the project be accepted? 1

2
850.00
850.00
3 850.00
PW(15%) -59.26
$850 $850 $850

PW  $2000   
1.15 (1.15)2 (1.15)3
 $59.26
Reject the project

 Correct Solution 1:  Correct Solution 2:

Use actual $ with inflation- Use constant $ with inflation-free
adjusted MARR MARR
1  ic 1.15
CF 5% CF i 1   1  9.52%
Year
(real $) inflation (actual $)
1 f 1.05
0 -2000.00 = -2000.00 CF
Year
1 850.00 x 1.05 = 892.50 (real $)
2 850.00 x (1.05)^2 = 937.13 0 -2000.00
3 850.00 x (1.05)^3 = 983.98 1 850.00
PW(15%) 131.67 2 850.00
3 850.00
$892.5 $937.13 $983.98
PW  $2000    PW(9.52%) 131.67
1.15 (1.15)2 (1.15)3
 $131.67 $850 $850 $850
PW  $2000   
1.095 (1.095) 2 (1.095)3
 $131.67
Accept the project
Accept the project

Inflation in Economic Analysis
1. Uniform inflation:
All cash flows inflate at the same rate
2. Differential inflation:
Different rates apply to different cash flows
 Tax considerations in economic study leads to differential

inflation
• Depreciation charges are not responsive to inflation
• Interest on debt is fixed, based on estimates of future

inflation rates; is not adjusted to actual inflation in
subsequent years

Inflation and Cash Flow Analysis
 Constant Dollar analysis

• Estimate all future cash flows in constant dollars.
• Use i’ as an interest rate to find equivalent worth.
 Actual Dollar Analysis

• Estimate all future cash flows in actual dollars.
• Use i as an interest rate to find equivalent worth.

Analysis under Uniform Inflation
 Uniform-inflation analysis:
• All cash flows inflate at a uniform rate
• Before-tax analysis
 Two methods when inflation is uniform:
• Constant cash flows discounted at inflation-free interest rates
• Actual cash flows discounted at market interest rates
 Both methods give the same results
 Constant-dollar analysis is more intuitive – familiarity with today’s
values
 Textbook refers to this case as before-tax analysis

Same PW with both methods: 1.PW(at i):

N
1.Constant dollars discounted at Ct
PW1  
inflation-free rate t 0 (1  i )t
2.Actual dollars discounted at

2.PW(at if):
inflation-adjusted rate
N
At N
Ct (1  f )t
Proof: PW2   
t  0 (1  i f ) t  0 (1  i f )
t t
• Ct: CF for year t in constant $

• For interest rates:
• At=Ct(1+f)t: CF for year t in
actual $ (adjusted for inflation) (1  f )t 1
1  i f  (1  i )(1  f )  
(1  i f )t (1  i )t
• i: inflation-free discount rate
• if=(1+i)(1+f)-1: inflation- • Thus: PW1=PW2
adjusted discount rate

Exercise: Asset price $100,000. 5-yr life with no salvage value. Net
annual benefit $28,000 without considering inflation. MARR=15%
w/o inflation. Inflation rate 8%. Evaluate using both the constant-
and the actual-dollar method. No tax considerations.
1. Constant $: i=15%
2. Actual $: if=(1.15)(1.08)-1=24.2%
Year Constant Dollars Actual Dollars

t Ct PW(15% ) At=Ct(1+f)^t PW(24.2% )
0 -$100,000.00 -$100,000.00 -$100,000.00 -$100,000.00
1 $28,000.00 $24,347.83 $30,240.00 $24,347.83
2 $28,000.00 $21,172.02 $32,659.20 $21,172.02
3 $28,000.00 $18,410.45 $35,271.94 $18,410.45
4 $28,000.00 $16,009.09 $38,093.69 $16,009.09
5 $28,000.00 $13,920.95 $41,141.19 $13,920.95
-$6,139.66 -$6,139.66

Differential Inflation
1. Prices of different classes of goods and services inflate at different

rates
– Effects of inflation might result in selecting a different alternative

than the one favored in the absence of inflation
– Analysis: actual dollar CF and market interest rates
– Example: two proposals have the same initial cost and annual
net benefits (in constant $). Proposal A generates energy
savings, while proposal B savings in labor. Energy prices escalate
at 20% annually, while the cost of labor at 10% annually.
 Proposal A should be selected

2. Interest on debt is not responsive to inflation

• Interest rate on a loan:
– Determined at the time of the agreement
– Specifies future payments in actual dollars
– Incorporates estimates of future inflation
– Is not adjusted when actual inflation is different than the estimated
ones
• When inflation rises faster than it was anticipated at the time of the
agreement:
– borrower’s benefit
– a project funded mainly through borrowed capital might be preferable
to one funded by equity capital
3. After-tax analysis involves cash flows non-responsive to inflation

• Depreciation charges: based only on the initial expenditure and do not
escalate with inflation
• Interest on borrowed capital is predetermined and is not adjusted for
inflation
 Textbook refers to differential-inflation analysis as after-tax actual
cash flow analysis

Summary of main concepts
What is Inflation?
 Value of Money
Earning Power
Purchasing power
 Earning Power
Investment Opportunity
 Purchasing Power
Decrease in purchasing power (inflation)
Increase in Purchasing Power (deflation)

Inflation Terminology
• Producer Price Index: a statistical measure of industrial price

change, compiled monthly by the BLS, U.S. Department of Labor
• Consumer Price Index: a statistical measure of change, over time, of
the prices of goods and services in major expenditure groups—such
as food, housing, apparel, transportation, and medical care—
typically purchased by urban consumers
• Average Inflation Rate (f): a single rate that accounts for the effect
of varying yearly inflation rates over a period of several years.
• General Inflation Rate (f ): the average inflation rate calculated
based on the CPI for all items in the market basket.

 Actual Money Units (i.e. Dollars) (An ): Estimates of future cash

flows for year n that take into account any anticipated changes
in amount caused by inflationary or deflationary effects.
 Constant Money Units (i.e. Dollars) (An’ ): Estimates of future
cash flows for year n in constant purchasing power, independent
of the passage of time (or base period).

 Inflation-free Interest Rate (i’): an estimate of the true earning

power of money when the inflation effects have been removed
(also known as real interest rate).
 Market interest rate (i): interest rate which takes into account
the combined effects of the earning value of capital and any
anticipated changes in purchasing power (also known as
inflation-adjusted interest rate).

Constant vs. actual dollars
Constant, or real dollars:

 Money units with constant purchasing power
 Approach suitable for before-tax analysis, when all cash flows
inflate uniformly
Actual, or future, or then-current dollars:
 Estimate of the amount of money units exchanged at the time of
the transaction
 More intuitive and versatile approach

Constant vs. actual dollars
(Actual dollars)=(Constant dollars)(F/P,f,N)

=(Constant dollars)(1+f)N
(Constant dollars)  (Actual dollars)(P / F, f ,N)

(Actual dollars)

(1  f)N
f: expected rate of inflation per year

N: year at which the cash flow occurs

Where Does f Come From?
 Measuring Inflation:
• price indices compiled periodically
• measure changes in prices of goods and services
• Department of Commerce and Department of Labor
 Consumer Price Index:
• most commonly used measure of inflation
• prices of: foods and beverages, housing, apparel and
upkeep, transportation, medical care, entertainment, and
other (education, personal care, etc.)
Use past CPI data to estimate future average inflation rate

Equivalence Calculation Under Inflation
1. Types of Interest Rate

Market Interest rate (i)
Inflation-free interest rate (i’)
2. Types of Cash Flow
In Constant Dollars
In Actual Dollars
3. Types of Analysis Method
Constant Dollar Analysis
Actual Dollar Analysis
Deflation Method
Adjusted-discount method

XXXXXXX prossima lezione XXXXXX
Copyright 2005 – prof. corrado lo storto

Economic Engineering - Inflation - Lectures 1&2

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Lectures in Engineering Economy

Prof. Corrado lo Storto

Engineering Economy/inflation/ 2005 /prof. corrado lo storto

Technically, inflation is the phenomenon of (continuously) rising prices

Inflation is worrisome for economy, but tend to be inevitable.

It is a fact of life and can significantly affect the economic comparison of

Engineering Economy/inflation/ 2005 /prof. corrado lo storto

1990 1990 2003

Engineering Economy/inflation/ 2005 /prof. corrado lo storto

You could purchase 63.69 You can now purchase 80

Engineering Economy/inflation/ 2005 /prof. corrado lo storto

Engineering Economy/inflation/ 2005 /prof. corrado lo storto

Engineering Economy/inflation/ 2005 /prof. corrado lo storto

The average inflation rate between 1963 and 2004 is

$1.17M in 2004 would have a purchasing power of $190,616

Engineering Economy/inflation/ 2005 /prof. corrado lo storto

If Jack invested his prize money in 1963 at 5.65% (inflation-free interest

P  $190, 616(P / F , 5.65%, 41)

Engineering Economy/inflation/ 2005 /prof. corrado lo storto

A price index is usually calculated to measure historical price level changes

A price index is the ratio of the historical price of some commodity or

Engineering Economy/inflation/ 2005 /prof. corrado lo storto

Engineering Economy/inflation/ 2005 /prof. corrado lo storto

base year: 1967  price index 1967=100

commodity price 1967 = $1.46/lb

Engineering Economy/inflation/ 2005 /prof. corrado lo storto

Most economic studies require the use of estimates that depend on

Engineering Economy/inflation/ 2005 /prof. corrado lo storto

Example 1: Average inflation rate Example 2: Average inflation

Engineering Economy/inflation/ 2005 /prof. corrado lo storto

Engineering Economy/inflation/ 2005 /prof. corrado lo storto

- government policies (i.e., price supports,

Engineering Economy/inflation/ 2005 /prof. corrado lo storto

year CPI Rate % year CPI Rate % year CPI Rate %

1966 97,2 2,9% 1978 195,4 7,7% 1990 391,4 5,4%

1967 100,0 2,9% 1979 217,4 11,3% 1991 408,0 4,2%

1968 104,2 4,2% 1980 246,8 13,5% 1992 420,3 3,0%

1969 109,8 5,4% 1981 272,4 10,4% 1993 432,7 3,0%

1970 116,3 5,9% 1982 289,1 6,1% 1994 444,0 2,6%

1971 121,3 4,3% 1983 298,4 3,2% 1995 456,5 2,8%

1972 125,3 3,3% 1984 311,1 4,3% 1996 469,9 2,9%

1973 133,1 6,2% 1985 322,2 3,6% 1997 480,8 2,3%

1974 147,7 11,0% 1986 328,4 1,9% 1998 488,3 1,6%

1975 161,2 9,1% 1987 340,4 3,7% 1999 497,6 1,9%

1976 170,5 5,8% 1988 354,3 4,1% 2000 509,0 2,3%

Engineering Economy/inflation/ 2005 /prof. corrado lo storto

91.7 100 561.23

Engineering Economy/inflation/ 2005 /prof. corrado lo storto

Engineering Economy/inflation/ 2005 /prof. corrado lo storto

It is possible to prepare price indexes not only for the individual

Engineering Economy/inflation/ 2005 /prof. corrado lo storto

Engineering Economy/inflation/ 2005 /prof. corrado lo storto

Engineering Economy/inflation/ 2005 /prof. corrado lo storto

According to definition, inflation describes the situation in which prices of

Engineering Economy/inflation/ 2005 /prof. corrado lo storto

Engineering Economy/inflation/ 2005 /prof. corrado lo storto

Engineering Economy/inflation/ 2005 /prof. corrado lo storto

Engineering Economy/inflation/ 2005 /prof. corrado lo storto

Net Cash Flow in Conversion Cash Flow in

1 100,000 (1+0.05)1 105,000

2 110,000 (1+0.05)2 121,275

3 120,000 (1+0.05)3 138,915

4 130,000 (1+0.05)4 158,016