Question

(i) In the following scenario, Between 2015 and 2016, The CPI of a small nation rose from 200 to 205 between these years and household incomes rose by 5% during these years. A claim is made that "Real incomes of the households remain unchanged: "

DO YOU AGREE/DISAGREE WITH THE CLAIM? EXPLAIN BRIEFLY IN 2-3 LINES ONLY.

(ii) : Who are the winners during high rates of inflation: Borrowers or lenders? Why?

Explain in 1-2 lines only.

Answer 1

Ans 1.) False

Since the percentage change in CPI is 2.5% (i.e [{205 - 200}/200] * 100) and the given percentage change in nominal income is 5% . Therefore change in real income = percentage change in nominal income - percentage change in CPI = 5 - 2.5 = 2.5 %

therefore the real income rose by 2.5%.

Ans 2.) Borrowers

Since the real value of money falls during the period of inflation ( because the same amount of money now buys lesser goods).therefore the real value is higher at the time of borrowing than the real value of money at the time of repayment due to inflation. i.e he pays in cheaper dollars.

• Additional example: suppose a person borrows $1000 at 10% interest rate and the inflation rate = 5%. therefore at the end of the year he pays $1100. but the real interest rate he is paying is just 5% ( i.e nominal interest rate - inflation rate). therefore the borrower benefits in real terms.