Engineering Economic Analysis

Meaning and Effect of Inflation 443

At theendof the year he could purchase:

Number of balls purchased at end of year = Dollars available for purchase at end of year

Cost per ball at end of year

In this case:

Dollars available at end of year = ($I000)(F/P,5.5%, 1) = $1055

Ball cost at end of year (inflated at 2%)=($5)(1 + 0.02)1=$5.10

Thus:

Number of balls purchased at end of year=$1055/5.10=207 golf balls

Tiger Woods can, after one year, purchase3.4%more golf balls than he could before. In this case

207 balls is about3.4%more than 200 balls.

If Inflation Is 8 %

As for the lower inflation rate, we would solve fori':

i'=(i- f)/O +f)

= (0.055- 0.08)/(1 + 0.08)

= -0.023 or -2.3% per year

In this case we can see that the real growth in money hasdecreasedby 2.3%, so that Tiger can
now purchase 2.3% fewer balls with the money he had invested in the bank. Even though he has

more money at the end of the year, it is worth less, so he can purchase less..
Regm:dlessof howinflationbehavesoverthe year,the bankwillpay Tiger$1055at the end
of the year. However, as wehave seen, inflationcan greatlyaffect the "real" growth of dollars over
time. In que of his State of the Union.addresses, ]>residentGeorge H. W. Bush called inflation

"that thie:fij'because .itstealsreal purchasing power frOIi1our dollars. We have seen this effect in

this examnte.

Let us continue the discussion of the effects of inflationby focusing now on cash flows

in our problems. We define dollars of two "types" in our analysis:

Actual dollars (A$): These are the dollars that we ordinarily think of when we think

of money. These dollars circulate in our economy and are used for investments

and payments. We can touch these dollars and often keep them in our purses and

wallets-they are "actual" and exist physically.Sometimes they are calledinflated

dollarsbecause they carry any inflation that has reduced their worth.

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