InflationEconomicAnalysis.pdfVIP

Inflation: Economic Analysis 1. Economic Analysis Including Inflation Our tools of economic evaluation and comparison must be modified to explicitly include the effects of inflation. This lecture shows how. 2. This Lecture Construct a cash flow based on estimates. Change the estimated cash flow to an actual cash flow. Change an actual cash flow to a real cash flow. Compute the NPW with either actual or real cash flows. Compute NAW and ROR considering inflation. These are the steps of the analysis process that are discussed in this lecture. Not all applications use every step. 3. Economic Analysis Estimate the several cash flow components using current data concerning costs and revenues. Escalate the costs and revenues using the escalation rates for each component. This results in a cash flow in actual dollars. For an analysis with real dollars use the general inflation rate to deflate the actual cash flow to a real cash flow. I want to emphasize that there are three kinds of cash flows. The first evaluates the various cash flow components with the prices that we would pay if they were bought today. These prices might come from current catalogs or current experience. Second, use escalation rates to estimate future expenditures and receipts. Escalation rates are like inflation rates but they can differ between the components of the cash flow. Electricity might escalate at a different rate than labor for instance. When prices are escalated the cash flow is in actual dollars. The analysis can proceed with the actual dollar cash flow or change it to real dollars. To change the actual dollar cash flow to a real dollar cash flow, deflate the amount in each period using the general inflation rate. 4. Estimating Cash Flows The first step is estimation. Here the estimato