EEC3701 – Unit 5

Unit 5: Inflation and exchange rates

5. Overview

This learning unit is based on chapter 8 of the prescribed book.

5.1 Essential theory and calculations in the prescribed book

Chapter _ Essential theory and calculations in the prescribed book

Pages
(SWK: 393) Definition of general price inflation.
Difference between price inflation and deflation.
Definition of the consumer price index (CPI)
Definition of the producer price index (PPI)
Why PPI is important for technologists and engineers.
(SWK: 394) The difference between nominal and real rands, pula, dollars, euro or
pounds.
The difference between nominal and real interest rates.
(SWK: 395-396) Work through example 8-1.
(SWK: 396-397) Work through example 8-2.
(SWK: 397) Work through example 8-3 a).
An alternative solution follows:
Relevant formula: FV = PV (1 + r)n
Given: FV = 30 000 and PV = 3 700
n = 2008 – 1953 = 55 years
From the above formula it follows that
30 000 = 3 700(1 + i)55
Divide on both sides of the equation sign by 3 700, then
8,1081 = (1 + i)55
Apply the logarithm function to both sides of the equation, then
Log(8,1081) = 55 log(1 + i)
Divide both sides of the equation sign by 55, then
0,016525 = log(1 + i)
To get rid of the log function on the right hand side, its inverse function can
be applied to both sides of the equal sign.

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 EEC3701 – Unit 5

Then, 100,016525 = 10log(1+i)

Then, 1,03878 = 1 + i
Subtract 1 from both sides of the equation, then
i = 0,03878 or approximately 3,88%.
(SWK:398) The correct interest rate to use in Engineering Economy studies

(SWK: 399-400) The relationship between inflation, the market and real interest rates.
Study equation 8-3

Do example 8-4.
Given: inflation rate (f) = 3%; nominal (market) interest rate = 8%
This is an annuity because of five equal amounts of $1 000 each.

 1  r n  1
The future, nominal value = 1000 x FVIFA(r, n) =   x 1000
 r 
 1  0,085  1
FV =   x 1000 = 5,8666 x 1000 = R5 866,60
 0 ,08 
To change this future nominal value to the present real value the formula, “FV
= PV (1 + r)n” is used. In this case the inflation rate is used to discount the
future nominal value to the present real value.
PV = FV / (1 + f)n = R5 866,60 / (1 + 0,03)5 = R5 060,58
(SWK: 410-411) Work through example 8-10

Content of cell D8:

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 EEC3701 – Unit 5

Content of cell E8:

Content of cell E14: ; the “16” is just a guess.

Content of cell E15:

5.2 Activities: Mastering unit 5

Do the following two activities to master this chapter of the prescribed work.

Activity 1: Summarise the prescribed sections of this unit in your own words. Make a
concise summary. Remember that summarising requires you to extract the essence of a
text, not to rewrite chunks from the textbook.

Activity 2: Complete myUnisa Tutorial 5. When you have answered all the questions,
please go to Forum 08 and upload your answers in the Tutorial 5 topic to discuss it with
other students.

For further self-enrichment, I suggest that you try to find information and video clips on the
internet that may help you to understand some of the concepts covered in this chapter.

You are now ready to move on to unit 6.