EFFECT OF

INFLATION
Dian Ratri Cahyani
Joshua Lokatili
Muhamad Ivan Farhan
INFLANTIONARY IMPACT
Inflation: Increase in amount of money needed to purchase same
amount of good or services. This results in a decrease in purchasing
power, for example one unit of money buys less good or services.
Money in one period of time 𝑡1 can be converted to the same value as
money in another period of time 𝑡2 by using the following equation

𝐴𝑚𝑜𝑢𝑛𝑡 𝑖𝑛 𝑝𝑒𝑟𝑖𝑜𝑑 𝑡2
𝐴𝑚𝑜𝑢𝑛𝑡 𝑖𝑛 𝑝𝑒𝑟𝑖𝑜𝑑 𝑡1 =
𝑃𝑒𝑟𝑖𝑜𝑑 𝑏𝑒𝑡𝑤𝑒𝑒𝑛 𝑡1 𝑎𝑛𝑑 𝑡2

Convert to constant value (CV) dollars, then use real rate i. If f =

inflation rate (% per year), n= the period between 𝑡1 and 𝑡2 the
equation above becomes:
Constant-value dollars = future dollars = then-current dollars
(1+ f)n (1+ f)n
 EXAMPLE
How much would be required today to purchase an item that increased in cost by
exactly the inflation rate? The cost 30 years ago was $1000 and inflation has
consistently averaged 4% per year.

Solution
Future dollars = constant value dollars(1 + f)n
= 1000(1 + 0.04)30
= $3243

Note: This calculation only accounts for the decreased purchasing power
of the currency. It does not take into account the time value of money
 Three Different Rates
► Real or inflation rate i – Rate at which interest is earned when effects of inflation are
removed; i represents the real increase in purchasing power
►Market or inflation-adjusted rate if – Rate that takes inflation into account.
Commonly stated rate everyday
►Inflation rate f – Rate of change in value of currency

Deflation
Opposite of inflation; purchasing power of money is greater in future than at present, However, if
deflation occurs at a more general level, say nationally, it is likely to be accompanied by the lack of money
for new capital. An- other result is that individuals and families have less money to spend due to fewer jobs,
less credit, and fewer loans available; an overall “tighter” money situation prevails.
PW Calculation with Inflation
 (1) Convert cash flow into constant-value (CV)
dollars and use regular i (real inflation rate),
where:
TWO WAYS TO
CALCULATE PRESENT (Note: Calculations up to now have assumed
WORTH ADJUSTED FOR
INFLATION constant-value dollars)

(2) Express cash flow in future (then-current)

dollars and use inflated interest rate for i
where if = i + f + (i)(f)
( Note: Inflated interest rate is the market
interest rate)
EXAMPLE
FW CALCULATION
WITH INFLATION
In future worth calculations, a future amount F can have
any one of four different interpretations:
• Case 1. The actual amount of money that will be
accumulated at time n.

• Case 2. The purchasing power of the actual amount

accumulated at time n, but stated in today’s (constant-
value) dollars.
• Case 3. The number of future dollars required at time
n to maintain the same purchasing power as today;
that is, inflation is considered, but interest is not.

• Case 4. The amount of money required at time n to

maintain purchasing power and earn a stated real
interest rate.
EXAMPLE
SOLUTION
 Capital • Current capital currency must be recovered with future
inflated currency. Since future currency has less buying

Recovery power than today’s currency, it is obvious that more

currency will be required to recover present

Calculations investment.

Adjusted for
Inflation