Muchen He

MECH 431


Updated 2018-08-08


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 \(f\) which is constant and plug it into the equation:


where \(n=2\) for 2 years. \(f=3.995\%\).


The relationship between real and nominal interest rate is:


The relationship between real and nominal dollar is:


or simply:

\[R_N=A_N(P/F, f, N)\]