Tag Archives: Economy

Dosa Economics

Hey folks, welcome to CCB. In today’s post we’ll have a look at Dosa Economics. Former RBI Governor Mr. Raghuram Rajan used Dosa as a measure to explain how inflation and interest rates work in the economy.

Let’s understand this with an example. Imagine you’ve got INR 100,000 and you deposit it in the bank and the bank pays you an annual interest of 10%. Therefore, at the end of the you’ve got INR 1,10,000.

Now assume instead of depositing INR 100,000 in bank you bought dosas worth INR 100,000 and price of each dosa is INR 50. Therefore, the numbers of dosas you bought are, INR 100,000 divided by INR 50 = 2000 dosas. Now assume that after one year the price of dosa moves from INR 50 to INR 55. Well, now assume that instead of buying dosa for INR 100,000, you decided to deposit that money in bank and thought of buying dosas a year later. Well, at the end of the year you’ve got INR 1,10,000 as the bank paid you 10% annual interest. Okay, now imagine you bought dosas for INR 1,10,000 and over the course of the year the price of dosa moved to INR 55 due to inflation (oil price, LPG price, salary hike of cook, hike in rent of the hotel etc.). So this time the number of dosas you can buy is INR 1,10,000 divided by INR 55 = 2000 dosas.

Well, if you look at the above paragraph you can see that irrespective of when you bought the dosas, whether you got it at the starting of the year or at the end of the year post receiving the INR 100,000 + INR 10,000 interest, the number of dosas you could buy is the same, that is 2000 dosas.

Well, now assume the bank paid you 8% annual interest and inflation rate is low and price of dosa moved to INR 53 per unit. Substituting this new value in the above equations gives you following results.

8% of INR 100,000 is INR 8000. And INR 1,08,000 divided by INR 53 = 2037.73.

Therefore, if you buy the dosa at the starting of the year when price of each dosa is INR 50 and you have INR 100,000 you can buy 2000 dosas but if you plan to deposit that money in bank and decide to buy the dosa post one year after receiving an annual interest of 8%, you can buy 2037 dosas. Yes, that is 37 extra dosas.

Therefore, according to Mr. Raghuram Rajan, high interest rate and high inflation doesn’t reap anything and decent interest rate and minimum inflation can be beneficial.

CAGR – Explained

CAGR stands for Compound Annual Growth Rate. It basically tells the annual rate at which the investment grew by taking compounding too into consideration. Let us understand it with an example. Imagine a bank personnel contacted you and said if you deposit ₹500,000 today, the bank would give you ₹10,00000 after 8 years. This may sound good to you and you probably said to yourself that let me deposit the money. Now let us calculate the CAGR for the above example and see whether it is worth it,

The formula to calculate CAGR is,

CAGR = { ( Final Amount ÷ Initial Amount ) ^ ( 1 ÷ n ) } – 1

I’m using flower bracket instead of the regular bracket to ensure things look less complicated.

‘^’ refers to exponent. ‘n’ refers to time period (in this case it denotes number of years). So let’s substitute the values in the formula.

CAGR = { ( 10,00,000 ÷ 5,00,000 ) ^ ( 1 ÷ 8 ) } – 1

CAGR = 9.05 %

I calculated this value using scientific calculator. I also verified the answer using online CAGR calculator. One can also use Microsoft Excel to calculate CAGR.

Well, the 9.05 % we got is decent. And it denotes that the above investment is good. Had we got something like 4%, then it was a hint that we should stay away from that investment, and the reason is inflation. Imagine you decided to put the money in bank at a 4% annual return and stayed in a rented house. In India the rent gets increased by 5% every year. Now if you look at the purchasing power, your money is getting increased by 4% every year while your expense is increasing at 5% every year. So that’s a bad investment. Well, if you are a long term reader of this blog you already know that I’m bad at Math, so I wouldn’t be going into too many permutations and combinations. Basically the rate at which your money grows should be greater than inflation. Well, the previous sentence sums up everything.

In the above example we calculated CAGR for bank return, in stock market we calculate CAGR for individual stock, an index etc.

Well, I hope that this post was useful. You can read more such posts on this website, so before closing the tab do check out other posts. Also consider sharing the post. See you soon 🙂

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