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Inflation / Deflation

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Inflation / Deflation

- Inflation is an increase over time in the price of a good or service with a constant value
- A gallon of 87 octane gasoline increases in price
- (but still only gets Dr. J. 32 miles down the road)

- Deflation is a decrease over time in the price of a good or service of constant value.
- A 2 GHz computer has decreased in price
- (but still does the same number of computations/min.)

Other Examples:

- Inflationary
- Tuition
- Fees
- Books
- Industry Salaries
- Cars
- Gas

- Deflationary
- CPU Memory
- Computers

- Constant
- Bread
- Milk

- Food & Drink
- Housing
- Clothing
- Transportation

- Medical Care
- Entertainment
- Personal Care
- Other Goods / Services

Average Inflation Rate (f)

- In most engineering econ problems, different items will have different inflation rates
- Average Inflation Rate is based on a market basket of goods
- – CPI or Consumer Price Index
- Simplifies cash flow in an analysis!

Deriving Equation for Inflation

P = 50,000

f = 10% increase annually

F1 = 50,000 + 50,000 (.10) = 50,000 (1 + .10) = 55,000

F2 = 55,000 + 55,000 (.10) = 55,000 (1 + .10)

= 50,000 (1 + .10)(1 + .10)

= 50,000 (1 + .10)2 = 60,500

F3 = 60,500 + 60,500 (.10) = 50,000 (1 + .10)2(1 + .10)

= 50,000 (1 + .10)3 = 66,550

Generally:Fn = P (1 + f )n

Constant Dollars vs. Actual Dollars

- Constant Dollars – represent constant purchasing power independent of the passage of time.
- Actual Dollars – an estimate of a future cash flow for Year n that take into account any anticipated changes in amount caused by inflationary or deflationary effects.

$A = $C (1+ f )n

$C = $A (1+ f )– n

1980

2012

ACTUAL

$

$785 / QTR Tuition & Fees

$785 (1+ f )32 / QTR Tuition & Fees

Constant Dollars vs. Actual Dollars

1980

2012

CONSTANT

$

$785 / QTR Tuition & Fees

$785 / QTR Tuition & Fees

f = Average Inflation Rate

Incorporating Inflation

- Inflation can be accounted for as an additional component on top of the interest rate:
- d = i + f + i•f(d replaces i in tables/equations)
- where:
- i is the effective interest rate
- f is the constant inflation rate

- where:

Real Life Examples

OSU research proposal budgets were supposed to contain a 4% cost increase factor for each successive year.

e.g. If I have a grad student helping with my research, for each year I employ her, I will need to figure a 4% increase in her stipend, her tuition waiver, her insurance contribution, …

What happens if we use a 4% average inflation rate for some common student-oriented prices?

1979

2012

$0.799 / gal

$0.799 (1+ 0.04 )33 = $2.92 / gal

F33 = $0.799 (F/P, 4%, 30) (F/P, 4%, 3)

= $0.799 (3.2434) (1.1249)

= $2.92 / gal

Example 1

Dr. J. used a motorcycle to get to college. At the Fall of 1979, the cost of a gallon of gas was 79.9 ¢. What should the cost have been in 2012 at a 4% average annual rate of inflation?

Find:

F33 (19792012)

Given:

P = $0.799 / gal

f = 4%

$3.35 / gal

Hardrockn Depot

(cash price)

July 11, 2012

Actual average inflation rate was 4.4 % / YR

1980

2012

$66.50 / Cr Hr

$66.50 (1+ .04 )32 = $233 / Cr Hr

F32 = $66.50 (F/P, 4%, 30) (F/P, 4%, 2)

= $66.50 (3.2434) (1.0816)

= $233.29 / Cr Hr

Example 2

Dr. J. went to Iowa State University for a B.S. in Computer Engineering. In Fall 1980, his fee card said he had to pay $665 for 15 credit hours of quarterly credit (which converts to $66.50 / sem cr hr). What would that cost be this year at a 4% average annual rate of inflation?

Find:

F32 (1980 2012)

Given:

P = $66.50 / Cr Hr

f = 4%

$114.30 / Cr Hr +$62.40 / Cr Hr (Engineering Fee) = $176.70 / Cr Hr

233.85 / Cr Hr (non-resident) SDSMT Catalog 2011-2012

Actual average inflation rate was 3.2 % / YR at SDSMT, and 5.5 % / YR at ISU

1980

2012

$254.20 (1+ .04 )– 32= $72.46 / QTR

F32 = $254.20 (P/F, 4%, 30) (P/F, 4%, 2)

= $254.20 (.3083) (.9246)

= $72.46 / QTR (2.4% inflation rate)

$254.20 / QTR (381.30 / sem)

SDSMT Fee Descriptions 2011/2012

Example 3

At Iowa State University in Fall 1980, Dr. J’s fee card showed a $120 technology fee. SDSMT’s tablet fee was $381.30 for academic year 2011-2012 (or $254.20 / QTR). What might the SDSMT fee have been back in 1980, using a 4% average annual rate of inflation?

Find:

P(2010 1980)

Given:

F32 = $254.20 / QTR

f = 4%

$120 / QTR paid for programmable TI calculators that were bolted to the tables at ISU…

Looks like 4% inflation rate is roughly right for prices, but maybe pay rates don’t keep up…

$25 000 / YR

1986

2012

$25 000 (1+ 0.04 )26 = $69 312/ YR

F26 = $25 000 (F/P, 4%, 25)(F/P, 4%,1)

= $25 000 (2.6658)(1.0400)

= $69 311/ YR

Example 4

Starting industry salary for Dr. J. as a computer engineer in 1986 was $25 000. Assuming a 4% average annual rate of inflation, what should the starting salary have been at graduation in 2012?

$65 370/ YR BLS low end for SD CpE May 2011

Find:

F26 (19862012)

Given:

P = $25 000 / YR

f = 4%

Computer Engineering salaries increased at a 3.92% inflation rate…

$5.50 / HR

1981

$5.50 (1+ 0.04 )31 = $18.55 / HR

F31 = $5.50 (F/P, 4%, 30)(F/P, 4%,1)

= $5.50 (3.2434)(1.0400)

= $18.55 / HR

2012

Example 5

In 1981 Dr. J. worked as a rodman / chainman for a land surveyor. Intern-type pay was $5.50 / HR then. Again, using the 4% average annual rate of inflation, what would the equivalent intern wage have been in the Summer of 2012?

$19.67 / HR average pay for Interns Summer 2011

Find:

F31 (1981 2012)

Given:

P = $5.50 / HR

f = 4%

… and Engineering Intern salaries beat the 4% inflation rate … 4.2% average rate

$3.35 / HR

1981

2012

$3.35 (1+ 0.04 )31 = $11.30 / HR

F31 = $3.35 (F/P, 4%, 30) (F/P, 4%, 1)

= $3.35 (3.2434)(1.0400)

= $11.30 / HR

Example 6

In 1976 Dr. J. got his first job sweeping floors at an aerial photography firm. The National Minimum Wage rose to

$3.35 / HR in 1981, when he quit. Using a 4% average annual rate of inflation, what should the equivalent minimum wage be in the Summer of 2012?

National Min. is $7.25 / HR 01 Jan 2012

$9.04 / HR Washington Min. Wage Law for 2012

(Highest Nationally)

Find:

F31 (1981 2012)

Given:

P = $3.35 / HR

f = 4%

Actual average inflation rate was 2.52% / YR

Concluding Thoughts

- Perhaps it isn’t that the cost of gas, tuition, fees, or engineering salaries have risen outrageously since
- “the good old days”…
- Our analysis shows one factor is that the high school degree, entry-level wages don’t keep up.
- Important to finish your degree quickly!