Engineering Economic Analysis

442 INFLATION AND PRICECHANGE

The mathematical relationship between the inflation, real and market interest rates is given

as:

i=i'+J+(i')(J) (14-1)

S1,1pposeTiger WqodSWaIltSltoinvest soWerecent golf winniIJ.gsin his hometown bank for one

year. Currently, th.e bank is paying a rate of 55% compounded annually.Assume inflation is

anticipateq to be 2% per year or 8%,per year for the year of Tiger's investment. In each case

identifyi, J,andi'.

SOLUTION,

If Inflation.Is 2 % per Year

F:t;ptnthe precedingdefinitions the inteJ;'estratethat the bankis paying is themarket rate (i).The

inflation rate (f) is given in the problem statement. What is left, then, is to find thereal interesi

rate (i').

i=5.5% f 2% i'=?

"

Sqlving fori'in Equation 14-1, weh.ave

"

II ii' + J+(i')(J)

i~ Ji + (l')(f)

i,--,.J. ,i'(1 +J)

i' (i---/)/(1 +J)

-- (O.05~'-i0.02)/(1+ 0.02)

-tI

II

ia -- ...- ,.--, !!Ii

.

II

.

1

'ffiismeans that Tiger Woods wi11Ji!lye3.4% lIlorepurchasingpowerwitb. tl,ledollaJ,"sinve$ted 1

iniltb.ataccQuntthan b,ehad ayear ago.At tl,leend of the year hy cWlPUfchas.e3.4%D:}oJ;'egoods ·

aq,dserviges than he could have atth.~beginmng oftheyear. A$~Il eXCll1lpleofthegroWth of his

I

tnQney,assUmehe was purchasiIlg golf balls that cost .$5eachalld tU!wheh.adillve$1:ed$loQOi'P

h;sh.ometown bank accoUnt.

~'~Mthebeginningoftheyearh~could pUl"Ch~se:!

~-"- = 1;1-':;;a;-"~ -;0;:. -, !='iif.Dollars today;,availabJe t~b~ halls J

}(Umbe~o1~m.purqfi~t~y ::::5::::::jc~~~-- __m 1

J:

.'Q.034or 3.4% per ye~

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