MECH 431

Inflation

Updated 2018-08-08

Inflation

Inflation is the rise of prices of goods and services (reduction in purchasing power) over time.

Inflation rate can apply to:

Example: average inflation rate

Given the base price of $100 in year 0, inflation rate in year 1 is 5%, year 2 is 3%, what is average inflation rate over two years?


First, find the real price at the end of year 2:

Then take average inflation rate which is constant and plug it into the equation:

where for 2 years. .

Definitions

The relationship between real and nominal interest rate is:

The relationship between real and nominal dollar is:

or simply: