The recent news about inflation gives us a great opportunity to talk about applying some of our engineering economics concepts and equations. From November 2020 to November 2021, the consumer price index – which is a metric that measures the cost of a variety of goods and services – rose 6.8% over that one-year time period.
What would inflation look like if we had an annual rate of 6.8% every year for 10 years (assuming an initial value of $1,000)?
We need to start with our equation for a future value given a present value, which is also known as a single payment compound amount
Using our values of 6.8% interest (i), 10 years (n), and present or initial value of $1,000, we now have:
Executing the calculation leads to:
Therefore, using our equation to find a future value given a present value calculation, we can find that if something costs $1,000 today, and it increased by 6.8% per year for 10 years, we would expect it to cost $1,930. This is partly due to the magical powers of compound interest – you will find that our answer is quite different than simply multiplying 6.8% times 10, and that’s because each year’s interest builds on itself resulting in an increase of 93% over the 10-year time period instead of simply 68%. – Daniel Findley, DTC Engineering Economics Instructors
