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Unformatted text preview: CHAPTER 8 PRICE CHANGES AND EXCHANGE RATES GENERAL PRICE INFLATION
An increase in the average price paid for goods and services bringing about a reduction in the purchasing power of money. GENERAL PRICE DEFLATION
A decrease in the average price paid for goods and services, resulting in an increase in the purchasing power of money. CONSUMER PRICE INDEX (CPI) One measure of price changes in our economy An estimate of general price inflation Tabulated by the Government A composite price index that measures price changes in food, shelter, medical care, transportation, apparel, and other selected goods and services used by average individuals and families CONSUMER PRICE INDEX
CPI is a Laspeyres type index Las CPIk = (Qk-1 x Pk) / (Qk-1 x Pk-1) ( ( Qk-1 = Preceding (base) year quantities Pk = Current-year prices CurrentPk-1 = Preceding (base) Year Prices CPI Annual Inflation Rate = [ (CPIk - CPIk-1) / CPIk-1 ] x 100 (CPI CPIk = Consumer price index for the current year CPIk-1 = Consumer price index for the preceding year OTHER INFLATION INDICATORS The CPI shows how the prices that consumers pay The change from year to year or month to month The PPI (Producer Price Index) shows how the prices paid to producers change from year to year or month to month The Implicit Price Deflator or GDP deflator shows how all prices in the economy change from one time period to another time period INFLATIONINFLATION-RELATED TERMINOLOGY Actual Turkish Liras (ATL) - (Current time frame) cash-flow TL) cashLiras : also current Liras, nominal Liras, or inflated Liras Liras, Liras, Real Turkish Liras (RTL) - Liras in terms of purchasing power TL) at some stated time period (i.e., base year): also constant Liras Base period (b) - Purchasing-power time reference Purchasing General price inflation ( f ) - Measure of change in purchasing power from one time to another Combined (nominal) interest rate ( ic) - Market interest rate: actual Liras paid for use of capital Real interest rate - (ir) - Inflation-free interest rate: real Liras Inflationpaid for use of capital RELATING ACTUAL LIRAS TO REAL LIRAS IRAS LIRAS Use the following to convert actual Liras, as of time k, Liras, to real Liras of constant purchasing power (RTL)K = (ATL)K [1/ (1+f)]K-b TL) (ATL) = (ATL)K(P / F, f %, k-b) (ATL) k In the base period, purchasing power of actual Lira and real Lira are the same Ex.: Suppose that your salary is 45,000 TL in year one, will increase at 4% per year through year four. Compute the real dollar equivalents (base time period being year 3), assuming that the general price inflation rate is 6% per year. RELATING COMBINED AND REAL INTEREST RATES AND GENERAL INFLATION RATE ir=(ic-f)/(1+f) Similarly, current-dollar internal rate currentof return is related to the real rate of return in the following way: IRR r = (IRR c - f ) / ( 1 + f ) Ex.: Suppose that your salary is 45,000 TL in year one, will increase at 4% per year through year four. Compute the real dollar equivalents (base time period being year 3), assuming that the general price inflation rate is 6% per year. Q: What is the base-year equivalent worth of the basefourfour-year actual and real salary cash flows at the end of year one if your personal MARRc is 10% per year (ic) ? (i 2003 Temel Yilli Tketici Fiyatlari Endeks Rakamlari 2003 Based Consumer Price Index Numbers Ocak January 2003 2004 2005 2006 2007 94.77 104.81 114.49 123.57 135.84 ubat February 96.23 105.35 114.51 123.84 136.42 Mart March 98.12 106.36 114.81 124.18 137.67 Nisan April 99.09 106.89 115.63 125.84 139.33 Mayis May 100.04 107.35 116.69 128.20 140.03 Haziran June 100.12 107.21 116.81 128.63 139.69 Temmuz July 2003 2004 2005 2006 2007 99.93 107.72 116.14 129.72 138.67 Austos August 100.09 108.54 117.13 129.15 138.70 Eyll Ekim September October 101.44 109.57 118.33 130.81 140.13 102.38 112.03 120.45 132.47 142.67 Kasim Aralik November December 103.68 113.50 122.14 134.18 104.12 113.86 122.65 134.49 Annual Average 100.00 108.60 117.48 128.76 Ex.: A recent college graduate has received the annual salaries shown in the following table over the past four years. During this time, the CPI has performed as indicated on the previous slide. Determine the annual salaries in year-2003 Liras, using the CPI as the indicator yearLiras, of general price inflation. End of Year 2003 2004 2005 2006 Salary (Actual TL) 12000 13000 14000 15000 Ex.: Annual expenses for two alternatives have been estimated on two different bases as follows: End of Year 1 2 3 4 Alt. A Actual YTL 120,000 132,000 148,000 160,000 Alt. B Real YTL 100,000 110,000 120,000 130,000 The inflation rate is 6% p.a. and the real rate of interest is 9% p.a.. Compute the present worth of both alternatives. ...
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This note was uploaded on 07/30/2009 for the course INDUSTRIAL 304 taught by Professor Temeldursun during the Spring '09 term at Boğaziçi University.
- Spring '09