Inflation - 1 McGill Faculty of Engineering MIME 310...

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Unformatted text preview: 1 McGill Faculty of Engineering MIME 310 Engineering Economy Section 2: How is inflation measured? • Price Indices (past) • Compound annual rate (future) Section 1: What is inflation? • Definition • Terminology Section 3: Effects of Inflation • How to handle inflation in project evaluation • An example Chapter 8 – Inflation Outline “One of the benefits of inflation is that kids can no longer get sick on a nickel’s worth of candy” , Journeyman Barber Magazine Inflation has a significant effect on project evaluation... How is it taken into account? 2 McGill Faculty of Engineering MIME 310 Engineering Economy Section 1: Definition and Terminology Definition Inflation decreases the purchasing power of money over time, i.e. the price of a fixed amount of goods or services increases . If their earnings do not keep pace with this increasing price trend, consumers become poorer over time. The price of particular items do not inflate, i.e. increase, at the same rates within a country or among countries – the rate of increase depends on location and markets. Thus, the general rate of inflation reflects the average rate of increase in prices over time within the economy of a country. 3 McGill Faculty of Engineering MIME 310 Engineering Economy Section 1: Definition and Terminology-15.0-10.0-5.0 0.0 5.0 10.0 15.0 20.0 YEAR INFLATION RATE (%) 1915 1925 1935 1945 1955 1965 1975 1985 1995 2005 ANNUAL RATES OF INFLATION IN CANADA (based on Consumer Price Index) 4 McGill Faculty of Engineering MIME 310 Engineering Economy Not all price changes are caused by inflation. Cyclical changes in supply and demand resulting from seasonal effects, random processes (e.g. weather conditions), speculation and economic cycles cause temporary changes that balance out over the longer term, while structural changes in supply and demand may cause permanent changes. Section 1: Definition and Terminology 5 McGill Faculty of Engineering MIME 310 Engineering Economy Reasons Used to Explain Inflation Section 1: Definition and Terminology • Demand pull – consumers have more money to spend, thus creating an increase in demand § Cost push – suppliers want to increase their real level of income § International forces (e.g. oil prices) § Inflation psychology – buy now on credit because loans can be repaid in the future with cheaper money 6 McGill Faculty of Engineering MIME 310 Engineering Economy Terminology Actual or Current monetary units – Purchasing power of money at the time of transaction (the term nominal may be used as well) ∴ purchasing power changes For project evaluation, the present is the reference point for making estimates of project parameters....
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This note was uploaded on 04/10/2008 for the course MINE 310 taught by Professor Bilido during the Spring '08 term at McGill.

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Inflation - 1 McGill Faculty of Engineering MIME 310...

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