Expert: Paul Henneman - 3/18/2005

Question
Goodday sir.To begin with,I must express my Gratitude for the way in which my previous two Questions on shares were answered.
 The Questions I have today are inspired by a series of Newspaper Articles I have fairly recently come accross.The first one stated that the price of a barrel of Oil today(hovering between $40 and $50)is cheaper than it was in the seventies eventhough the figure per barrel was lower than it is today.The other one stated that,in the early eighties,when video cassette recorders were released to the U.K market,the price was about £300.It went on to state that in today's money,that figure would be about £2000. The final one stated that the 1966 james bond film "thunderball" was the highest grossing of all time inspite of the fact that the 2002 film "die another day" earned in excess of $400 million-the highest ever figure for a bond movie!
With the aid of reasonably detailed explanations for each,I would like to know the answers to the following Questions:
What causes the value of money to vary in this way and is there a formula for calculating the prices in today's money of goods that were sold in the past?
If I decide to buy shares in a company at £3 each today,and in 10 years time,the price rises to £12,is there not a danger that the new price will be worth less than the old price of £3?
How much would £3000(or $3000 for your own circumstances) put in a bank Account in 1983 be worth today? Would the money available for withdrawal have been affected by interest rates or something in addition to?
Would it be correct to assume that V.C.R Manufacturers have suffered losses in view of the fact that the price of a v.c.r has fallen from a high of £300(£2000 in value terms) in 1983 to £50 today?

Answer
Steve,
  Thank you for your questions! This is a broad topic, so I will provide what I can in the available space, but do not hesitate to follow up for more.
  Your questions overall revolve around the topic of inflation. This is the process where goods and services tend to cost more and more over time. You refer to everything in pounds, and I want to warn you that I am not very familiar with your specific economy. However, in the United States, a generally accepted normal rate of inflation is 3 to 4% per year. Some years can be higher, others lower, but that is a good guideline. This figure is also not the same for all goods and services, some types of items can see a much higher rate of inflation than others. But in general, your cost of living in the United States can be expected to rise overall by 3 to 4% a years. Salaries and income also rises over time, sometimes by more than this figure (thereby improving living standards), or sometimes less (resulting in less disposable income and generally a lowering of living standards). This rate of inflation can vary dramatically with different economies. For example, some Latin American economies have seen several THOUSAND percent inflation rates during economic downturns in very short time frames.
   Regarding your examples, the price of oil is a good one. It is true that oil costs much more today than in the late seventies. However, when you factor in this inflation, it is generally accepted that oil still does not cost as much as it did back then. In the United States, we are paying an all time high amount for a gallon of gas, about $2.10 per gallon. However, due to inflation, this is actually less in value than a gallon of gas cost in the 1970's.
  There is no easy forumula for calculating this. This is because the rate of inflation varies over time, and would make the exact computation of this difficult. However, I would suggest taking a general figure of 4% for the US economy per year. Some quick research could probably get find a general figure such as this for your economy as well.
  Yes, there is a danger that if you buy stock, if it does not rise enough, it will be worth less in 10 years than it is now even if it goes up small amount in share price. Again it is all related to how much buying power your money has. In the US, a stock should on average increase in value by at least 4% to offset inflation in order to make a true profit for the investor.
  It is good that you are asking these types of questions. An example of why this is of concern is money market accounts here in the US. The highest yield money market account is about 2% annually here in the US. This will not keep up with inflation, and will lose 'value' for the investor over time. But many investors still use money market accounts as a safe investment. This type of account should really be considered as a place to park money, not an investment as there is little hope of seeing any true economic gain.
  However, it would not be correct to assume that VCR manufacturers have suffered losses because the price of a VCR has fallen by so much, even if inflation would mean they should rise in price. At technology improves, the cost of manufacturing a VCR comes down. Also, as this type of technology becomes more accepted by more people, a far greater number of VCR's are sold, meaning that manufacturers can afford to have a smaller profit margin on each unit and still pay for all expenses and earn a profit. They are still likely earning the same percentage, or close to it, for each machine. I don't know the exact figures, but perhaps it cost $250 to make a VCR twenty years ago, and they sold for $300. Today it may cost $20 per vcr to make, and they sell for $50. But they probably also sell a hundred times more vcr's today than 20 years ago, so the VCR manufacturers are actually making much more in profit (but less for each vcr). This generally theory can apply to almost all technology items.
  I don't want to give you too much here, as this sounds like it might be a homework question and we are not supposed to answer those. Here is the definition of 'inflation' by "Barrons Dictionary of Finance and Investment Terms":
"rate of change in prices. Two primary US indicators of the inflation rate are the consumer price index and the producer price index, which track changes in prices paid by consumers and by producers. The rate can by calculated on an annual, monthly, or other basis." page 280
The consumer price index is perhaps what you may be more interested in, and this can be looked up in any number of places. I don't have the current figure handy, but a quick google search could find it.
Again, please keep in mind that all of the above pertains to your questions relating to the US market, as that is the limit of my knowledge. However, most of this is still perfectly relevant to your questions.

I hope this helps! Please do not hesitate to follow up with me if I can be of any further service,

Sincerely,
Paul Henneman
President
ValuEngine, Inc.
www.ValuEngine.com
www.VEInstitutional.com
(800) 381-5576