Inflation is the increase in the cost of goods and services over time. Inflation adjustment calculates the prices of goods and services at different times, adjusted to economic indicators. A good example that illustrates this is the price of a gallon of milk, how that has changed over time and what a future cost of living might be based on an assumed inflation rate.
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Assume the cost of milk is £3 per gallon in Year 1. We will calculate the cost of the same gallon of milk in Year 10. Assume that the inflation rate is 8 per cent annually.
Using the inflation percentage, covert it to a factoring number according to the following equation: %/100 + 1 = 8/100 + 1 = 1.08.
Take the factoring number and raise it to the power equal to the number of years in question as follows: 1.08^10 = 2.16. This is the index number.
Take the Year 1 cost of milk and multiply it by the index number to determine the future cost of milk: £3 times 2.16 = £7.0, more than doubling the cost.
How to Calculate Inflation Adjustment
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