W.14_Lilly Wasitova_Price Changes and Inflation Rates


Problem Statement

 

Using the data already analyzed in my previous blogs, a study on the price increments over the 5 years period of time from 2007 to 2011 for the Big Mac™ Price based on US Dollar from [6] and the Gold Price from [4], as we can see it in the below table:

 


Table 1 : Big Mac™ Price [6] and Gold Price [4] from 2007 to 2011

 

Alternative Solutions

 

As we know that price increments over the time usually caused by the inflation, which according to [11] means “the ongoing fall in the overall purchasing power of the monetary unit” and according to [1] can affect the economic comparison of alternatives. With the Monthly Inflation Rate from [10], taken from the US CPI (Consumer Price Index) we can retrieve the data for the year 2006 to present in Table 2, as below:

 


Table 2 :Monthly Inflation Rate [10] from 2006 to 2011

 

The plotted Inflation Rate with its control chart is in Figure 1 :

 


Figure 1 : The Monthly Inflation Rate [10] and its Control Chart from 2006 to 2011

 

 

Selection Criteria

 

The selection criteria will be:

  • Using the data period from the year 2006 to 2011 for the Inflation Rate (accumulative per year) and from 2007 to 2011 for the Big Mac Price and Gold Price, using average values for price of selected data.
  • Calculate the Real Dollar (R$) based on the Big Mac™ Price, Gold Price and US Inflation Rate (f) for all selected Countries/Area.
  • Compare the result with the Actual Dollar (A$) and the actual price changes

 

 

Analysis and Comparison of Alternatives

 

The Real Dollar calculation is following the formula from [1]:


Where :             R$ = Real Dollar

A$ = Actual Dollar

k = Time Period

b = Base Time Period

f = Inflation Rate (yearly rate)

 

Gives us the following result:


Table 3 : Calculated Real Dollars R$ for the Big Mac™ Price [6] and Gold Price [4] from 2007 to 2011

 

To compare the result with the actual price changes in percent, as we can see below is showing negative values that indicates a price decrease as an impact of the Global Economic Recession in 2007 – 2008. The baseline year is the year 2007 and the increments are calculated on yearly basis.

:

Table 4 : Changes of the Big Mac™ Price [6] and Gold Price [4] from 2007 to 2011


Figure 2 : Accumulative Increase of the Big Mac Price and Gold Price from 2007 to 2011

 

Selection of the preferred alternatives

 

The absolute values for the price difference and calculated Real Dollar are listed in Table 5 and Table 6 and the accumulative difference over 5 years are plotted and compared in Figure 3 below.

 


Table 5 :The Absolute Big Mac™ and Gold Price Difference between Actual $ and Real Dollar Year 2007 to 2011

 

 


Table 6 : The Big Mac™ and Gold Price Difference from Year 2007 to 2011

 


Figure3 : The Accumulative Difference Over 5 Years for Big Mac™ and Gold from Year 2007 to 2011

 

Performance Monitoring & Post Evaluation of Results

From the above calculation and analysis, we can say that:

  1. The Monthly Inflation Rate between the Years 2006 to 2011 is out of control, since one point fall outside the control limit, namely in November 2008 with -1.91%. Even though the accumulative yearly rate for 2008 was kept slightly positive, but the actual recession impact can be seen here, since the highest inflation rate is also in the same year with 1.01% in June 2008 and there are two points for October and December 2008 that are in Zone A to LCL. In general, the inflation rate in 2008 is out of control.
  2. The Real Dollar Calculation considering the inflation rate for the Big Mac™ Price in absolute value has actually no significant impact, if only we calculate for the consumer needs, compared to the actual price change.
  3. The Big Mac™ actual relative price changes for other Countries/Area than United States are much higher than the United States, due to the fact that that Counties/Area have different inflation rate, which is not under consideration here.
  4. The accumulative Big Mac™ Price change for United States over 5 years period is 15.94%, is still higher than the accumulative inflation rate for 5 years of 11.27%. This may happen due to the profit and services cost component.
  5. The Inflation Rate has less impact on the increase of The Gold Price.

 

References:

  1. Sullivan, William G., Wicks, Elin M. & Koelling, C. Patrick (1942), Engineering Economy 15th Edition, Singapore: Prentice Hall, Inc.
  2. Michael Bassard & Diane Riter (2010), The Memory Jogger 2nd Edition, Canada, GOAL/QPC
  3. XE, The World’s Favorite Currency Site http://www.xe.com/ucc/
  4. KITCO http://www.kitco.com/scripts/hist_charts/yearly_graphs.plx
  5. John K. Hollmann, PE CCE (2006), Total Cost Management Framework, A Process for Applying the Skills and Knowledge of Cost Engineering 1st Edition, USA, AACE International – The Association for the Advancement of Cost Engineering
  6. The Economist, http://www.economist.com/node/12991434?story_id=E1_TNJJTQPQ
  7. Michael R. Pakko and Patricia S. Pollard (2003), Burgernomics: A Big Mac™ Guide to Purchasing Power Parity, The Federal Reserve Bank of St. Louis
  8. International Monetary Fund (April 2009), World Economic Outlook – Crisis and Recovery, IMF Multimedia Services Division
  9. Chronology: Financial Crisis Spreads From US to World Markets (October 4th, 2008),

About Lilly Wasitova

Goal oriented professional who like to have fun
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2 Responses to W.14_Lilly Wasitova_Price Changes and Inflation Rates

  1. DrPDG says:

    Once again, you have done some incredibly interesting and important research and I am very excited over what you have done.

    My one and only concern is where are you taking us with this? You have a LOT of important and valuable pieces of a puzzle, but in the coming two weeks you are going to have to create a picture that is going to appeal to COST ESTIMATORS/PROJECT CONTROLS people.

    My SUGGESTION would be to use your research to prove (or DISPROVE) that using gold equivalency as the basis to project costs into the future is a valid (or invalid) approach to take in times of uncertainty. (The argument being that the difference between the historic mean cost of gold and the cost of gold today (regardless of the currency) reflects the beta or “risk premium” . (See Capital Asset Pricing Model)

    Explained another way, the difference between what an ounce of gold could purchase historically and what an ounce of gold can purchase today, reflects the perceived riskiness of the currency.

    And that the trend can be used to reasonably and relatively accurately, predict the future, especially where there is instability between the various currencies.

    Keep up the good work and I hope to see a draft of your paper really SOON!! Keep in mind I will be teaching all next week, so may not be able to turn your paper around immediately…

    BR,
    Dr. PDG, Jakarta

  2. Lilly Wasitova says:

    Thanks Pak PDG ….

    am working on it …. so many perspectives 😀 and :(( at teh same time pak ….

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