Suppose Rina is an avid reader and buys only mystery novels. Rina deposits $4,000 in a...

Suppose Rina is an avid reader and buys only mystery novels. Rina deposits $4,000 in a bank account that pays an annual nominal interest rate of 15%. Assume this interest rate is fixed—that is, it won't change over time. At the time of her deposit, a mystery novel is priced at $20.00.

Initially, the purchasing power of Rina's $4,000 deposit is.......... mystery novels. ???????

For each of the annual inflation rates given in the following table, first determine the new price of a mystery novel, assuming it rises at the rate of inflation. Then enter the corresponding purchasing power of Rina's deposit after one year in the first row of the table for each inflation rate. Finally, enter the value for the real interest rate at each of the given inflation rates.

Hint: Round your answers in the first row down to the nearest mystery novel. For example, if you find that the deposit will cover 20.7 mystery novels, you would round the purchasing power down to 20 mystery novels under the assumption that Rina will not buy seven-tenths of a mystery novel.

	Annual Inflation Rate
	0%	15%	18%
Number of Novels Rina Can Purchase after One Year	?	?	?
Real Interest Rate	?	?	?

When the rate of inflation is equal to the interest rate on Rina's deposit, the purchasing power of her deposit ............... over the course of the year.??????

Solutions

Expert Solution

Initially, the purchasing power of Rina's deposit is

Initial deposit/Price

= 4000/20

= 200 novel

	0%	15%	18%
Number of novels Rina can purchase after one year	230	200	195
Real interest rate	15%	0%	-3%

-When there is no inflation,the price of a novel would be 20 after a year and the deposit will increase to 4000*(1+0.15) = 4600

Purchasing power = 4600/20 = 230

Real interest rate = Nominal - inflation = 15-0=15%

-When the inflation is 15%,the price would increase to 20*(1+0.15) = 23

Purchasing power = 4600/23 = 200

Real interest rate = 15-15=0%

-When the inflation is 18%,the price would increase to 20*(1+0.18) = 23.6

Purchasing power = 4600/23.6 = 195

Real interest rate = 15-18=-3%

When the rate of inflation is equal to the interest rate on Rina's deposit, the purchasing power of her deposit remains the same over the course of the year

Rahul Sunny answered 1 year ago

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