MSci261-2007-Ch_9

MSci261-2007-Ch_9 - Chapter 9 Inflation MSci 261:...

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Chapter 9 1 Chapter 9 Chapter 9 MSci 261: Managerial and Engineering Economics Spring 2007 Instructor: Bon Koo                             Inflation Inflation
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Chapter 9 2 Overview Overview Prices of goods and services change over time. Inflation: Increase in average prices Deflation: Decrease in average prices Inflation The “purchasing power” of money decreases: you can buy less with a given amount of money. It affects cash flows associated with a project. Managers should incorporate an expectation of inflation in the project evaluation.
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Chapter 9 3 1. Basics of inflation (1) 1. Basics of inflation (1) Why inflation? Increase in money supply: “Too much money chasing for too few goods” Decline in productivity: When the cost of production goes up, firms increase the price to recover the cost. Supply shock: e.g., a sudden increase in oil price Is inflation bad? If it is anticipated and the size is small, it is considered to be necessary to a healthy economy. HOWEVER,
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Chapter 9 4 1. Basics of inflation (2) 1. Basics of inflation (2) If inflation is not anticipated and the size is large, Firms will invest less due to uncertain cost of investment. Consumers will save less and spend more due to the loss of purchasing power in the future. If inflation rate is greater than other countries, domestic products become less competitive. Hyperinflation Extreme inflation which is “out of control.” It disrupts the market economy. German hyperinflation in 1922 – 1923: 322% per month. On October 1923, the rate was 29,000%. (A $1 pencil today costs $290 next month!)
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Chapter 9 5 1. Basics of inflation (3) 1. Basics of inflation (3) Hyperinflation 1923-24 in Germany: A woman in Germany feeds her stove with currency notes. The notes burn longer than the amount of firewood they can buy.
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Chapter 9 6 1. Basics of inflation (4) 1. Basics of inflation (4) Hyperinflation 1993 in Yugoslavia: A 500,000,000,000 (500 billion) dinar banknote in 1993, the largest nominal value ever officially printed in Yugoslavia. (The highest denomination in 1988 was 50,000 dinar.) In 1994, a 1 new dinar was exchanged for 1 billion old dinar.
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Chapter 9 7 1.1. Measuring inflation (1) 1.1. Measuring inflation (1) Measuring inflation Prices of goods and services do not move together. Inflation is measured by the price change of a “ basket ” of goods and services over time. Composition of the basket Producer price index (PPI): production inputs Labor price index: wages Consumer price index (CPI) Most common price index Inflation is often measured by the CPI.
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Chapter 9 8 1.1. Measuring inflation (2) 1.1. Measuring inflation (2) CPI (continued) The basket includes food, shelter, medical care, transportation, apparel, etc. which are used by average
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This note was uploaded on 03/13/2009 for the course MSCI 261 taught by Professor Bonkoo during the Spring '09 term at Waterloo.

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MSci261-2007-Ch_9 - Chapter 9 Inflation MSci 261:...

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