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
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
1.
Food & Drink
5.
Medical Care
2.
Housing
6.
Entertainment
3.
Clothing
7.
Personal Care
4.
Transportation
8.
Other Goods / Services
– 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.
Constant Dollars vs.
Actual Dollars
CONSTANT
$
1980
2012
$785 / QTR
Tuition & Fees
$785 / QTR
Tuition & Fees
$C = $A (1+ f )– n
$A = $C (1+ f )n
ACTUAL
$
1980
2012
$785 / QTR
Tuition & Fees
$785 (1+ f )32 / 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
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?
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?
1979
Find:
F33 (1979 2012)
2012
$0.799 / gal
Given:
P = $0.799 / gal
f = 4%
$0.799 (1+ 0.04 )33 = $2.92 / gal
$3.35 / gal
Hardrockn Depot
(cash price)
F33 = $0.799 (F/P, 4%, 30) (F/P, 4%, 3) July 11, 2012
= $0.799 (3.2434) (1.1249)
= $2.92 / gal
Actual average inflation rate was 4.4 % / YR
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?
1980
Find:
F32 (1980 2012)
2012
$66.50 / Cr Hr
Given:
P = $66.50 / Cr Hr
$66.50 (1+ .04 )32 = $233 / Cr Hr
f = 4%
F32 = $66.50 (F/P, 4%, 30) (F/P, 4%, 2)
= $66.50 (3.2434) (1.0816)
= $233.29 / Cr Hr
$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
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?
1980
Find:
2012
P (2010 1980)
Given:
F32 = $254.20 / QTR
f = 4%
$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
$254.20 / QTR
(381.30 / sem)
SDSMT Fee
Descriptions
2011/2012
(2.4% inflation rate)
$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…
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
Find:
BLS low end
for SD CpE
May 2011
$25 000 / YR
F26 (19862012)
1986
Given:
P = $25 000 / YR
2012
$25 000 (1+ 0.04 )26 = $69 312/ YR
f = 4%
F26 = $25 000 (F/P, 4%, 25)(F/P, 4%,1)
= $25 000 (2.6658)(1.0400)
= $69 311/ YR
Computer Engineering salaries increased at a 3.92% inflation rate…
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)
$5.50 / HR
Given:
P = $5.50 / HR
1981
2012
$5.50 (1+ 0.04
)31 =
$18.55 / HR
f = 4%
F31 = $5.50 (F/P, 4%, 30)(F/P, 4%,1)
= $5.50 (3.2434)(1.0400)
= $18.55 / HR
… and Engineering Intern salaries beat the 4% inflation rate … 4.2% average rate
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
Find:
F31 (1981 2012)
Given:
P = $3.35 / HR
f = 4%
$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
Actual average inflation rate was 2.52% / YR
$9.04 / HR
Washington
Min. Wage
Law for 2012
(Highest
Nationally)
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!