module 10 inflation

8/14/2019 Module 10 Inflation

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Module 10: Inflation

SI-4251 Ekonomi Teknik

Muhamad Abduh, Ph.D.


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Muhamad Abduh, Ph.D.SI-4251 Ekonomi Teknik2

Outline Module 10

Inflation

Inflation Rate

Present Worth Calculation

Cost Estimation


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Inflation The prices for goods and services are driven upward or downward

because the effect of factors in economy.

Inflation is term related to the change in price level in economy,at which the amount of goods and/or services purchased isreduced for the same amount of money spent.

Deflation is the term for opposite condition

Price Index is a ratio used to measure the historical price-levelchanges for a particular commodities or general cost of living(e.g., Consumer Price Index (CPI)

CPI

Year00

2 00

3 00


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Definitions

(Inflation rate f

) - (Inflation free interest rate i)

(Inflated interest rate if)


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Inflation Rate (+The rate of inflation f) ( (or deflation -f)) is calculated

.based on changes in prices in successive years This.rate has a compounding effect ,Inflated interest

(Annual inflation rate for year +t 1)

Dollars in period t1

Today s dollar

( ) ( )

( )t

tt

CPI

CPICPIf

= +

1

( )

( )nt

tf

$$

+=

1

2

1

( )

21

2

1

$$

tt

t

t

Inflation

=

iffiif ++=


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Present Worth Calculation using Todays Dollars

An item that cost $ 1,000 today is subjected to10% rate of inflation and 8% of interest

(1)EOY

(2)Cost increase dueto inflation

(3)Future cost inthen dollars

(4) = (3)/(1+f)n

Future cost in todaysdollar

(5) = (4)(P/F, i, n)Present worth

0 1,000 1,000 1,000

1 100 1,100 1,000 925

2 110 1,210 1,000 857.3

3 121 1,331 1,000 793.8


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Present Worth Calculation using InflatedRate

An item that cost $ 1,000 today is subjectedto 10% rate of inflation and 8% of interest

Inflated interest rate, if= I + f + if= 0.08 +

0.1 + 0.1*0.08 = 0.188 (18.8%)

(1)EOY

(2)Cost increase due toinflation

(3)Future cost in thendollars

(4) = (3)(P/F, if, n)

Present worth0 1,000 1,000

1 100 1,100 925.9

2 110 1,210 857.3

3 121 1,331 793.8


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Exercises1.Bambang is scheduled to receive Rp.50 million payment from a

trust fund 10 years from now. The inflation rate is estimated atan average of 6% annually. Find the constant value (Rp)equivalent of this payment if the constant-Rp base is (a) t = 0,(b) t = 5 , and (c) t = -3 (three year prior to the present)

2.A payment of Rp 200 millions is to be received 8 years from now,followed by additional Rp 150 millions 10 years afterward.Alternatively, a sum of Rp 320 millions can be received at theend of 15 years. If the annual rate of inflation is 5% and interestrate is estimated at 9%, which installment is preferred, constantdollars analysis

3.The following shows the consumer price index recorded over the

period of 9 years Year CPI Year CPI Year CPI

1995 1.7 1998 3.1 2001 2.6

1996 1.9 1999 2.7 2002 2.9

1997 1.8 2000 2.5 2003 2.9

determine the inflation rate at year 1998, 2000, and 2002


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Cost Estimation Cost at any point in time can be estimated using

comparison of cost at any other time ost Indexis a ratio of the cost of an item today to

the cost at some point in time

Ct = estimated cost at present time t C0 = cost at base time t0 It = index value at time t I

0 = index value at time t0

ost Capacity Factoris a ratio of a certain volumeto the other volume

C2 = estimated cost at capacity Q2 C1 = cost at capacity Q1 Q1 = capacity 1 Q

2 = capacity 2 x = , ,capacity factor exponent varies depending type of product

0

0I

ICC t

t=

x

Q

Q

CC

=

1

2

12


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Exercises

1.An investor is considering to build a new oil refinery plantwith the capacity of 800,000 barrel per day (bpd). 15years ago a similar plant with a capacity of 700,000 bpdwas built for US$ 575 million. If the inflation is estimatedat 4% annually, what is the estimated cost for buildingthe new plant? Cost capacity index for oil refinery is

0.642.An item is bought for Rp7,5 million five years ago when the

consumer price index is recorded at 112 point. Today,when the index is calculated at 119, what is theestimated cost of the same item?

3.What will be the value of a bulldozer cost index in 2010 if itwas 276.5 in 2003, when it increases 6% a year?

module 10 inflation

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