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Inflation / Deflation

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)

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Inflation / Deflation

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  1. 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.)

  2. Other Examples: • Inflationary • Tuition • Fees • Books • Industry Salaries • Cars • Gas • Deflationary • CPU Memory • Computers • Constant • Bread • Milk

  3. 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!

  4. 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

  5. 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.

  6. $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

  7. 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

  8. 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?

  9. 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 (19792012) 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

  10. 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

  11. 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…

  12. $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 (19862012) Given: P = $25 000 / YR f = 4% Computer Engineering salaries increased at a 3.92% inflation rate…

  13. $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

  14. $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

  15. 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!

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