newnansm14 - Chapter 14: Inflation and Price Change 14-1...

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Chapter 14: Inflation and Price Change 14-1 During times of inflation, the purchasing power of a monetary unit is reduced. In this way the currency itself is less valuable on a per unit basis. In the USA, what this means is that during inflationary times our dollars have less purchasing power, and thus we can purchase less products, goods and services with the same $1, $10, or $100 dollar bill as we did in the past. 14-2 Actual dollars are the cash dollars that we use to make transactions in our economy. These are the dollars that we carry around in our wallets and purses, and have in our savings accounts. Real dollars represent dollars that do not carry with them the effects of inflation, these are sometimes called “inflation free” dollars. Real dollars are expressed as of purchasing power base, such as Year-2000-based-dollars. The inflation rate captures the loss in purchasing power of money in a percentage rate form. The real interest rate captures the growth of purchasing power, it does not include the effects of inflation is sometimes called the “inflation free” interest rate. The market interest rate, also called the combined rate, combines the inflation and real rates into a single rate. 14-3 There are a number of mechanisms that cause prices to rise. In the chapter the authors talk about how money supply, exchange rates, cost-push, and demand pull effects can contribute to inflation. 14-4 Yes. Dollars, and interest rates, are used in engineering economic analyses to evaluate projects. As such, the purchasing power of dollars, and the effects of inflation on interest rates, are important. The important principle in considering effects of inflation is not to mix-and-match dollars and interest rates that include, or do not include, the effect of inflation. A constant dollar analysis uses real dollars and a real interest rate, a then-current (or actual) dollar analysis uses actual dollars and a market interest rate. In much of this book actual dollars (cash flows) are used along with a market interest rate to evaluate projects this is an example of the later type of analysis. 14-5 The Consumer Price Index (CPI) is a composite price index that is managed by the US Department of Labor Statistics. It measures the historical cost of a bundle of “consumer goods” over time. The goods included in this index are those commonly purchased by consumers in the US economy (e.g. food, clothing, entertainment, housing, etc.).
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Composite indexes measure a collection of items that are related. The CPI and Producers Price Index (PPI) are examples of composite indexes. The PPI measures the cost to produce goods and services by companies in our economy (items in the PPI include materials, wages, overhead, etc.). Commodity specific indexes track the costs of specific and individual items, such as a labor cost index, a material cost index, a “football ticket” index, etc. Both commodity specific and composite indexes can be used in engineering economic
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This note was uploaded on 08/13/2010 for the course IME IME 314 taught by Professor Freeman during the Spring '10 term at Cal Poly.

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newnansm14 - Chapter 14: Inflation and Price Change 14-1...

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