Question

This question has 5 parts.

a. Assume that currently the nominal interest rate is 4% and the price of your favorite good today is P = $100 per unit. You lend $10,000 for a year to a friend. If instead you spent the money today, you would be able to buy 100 units of your favorite good.

b. Next year, your friend will pay you back 10,400 dollars.

c. Next year, the price of your favorite good increases by 1 percent. With the money that your friend pays you back next year, you will be able to buy 102.97 units of your favorite good.

d. The amount of the good that you can buy with your money is called the purchasing power of the money. As a result of your lending, the purchasing power of your money will increase by ____ percent.

If you had not lent your money and instead kept it under your mattress, its purchasing would decrease by ____ percent (enter this percentage reduction as a positive number).

e. Suppose that you lent your money at 4%, but next year the price of the good increased by 5%. Then the purchasing power of your money would decrease by ____ percent (enter this percentage reduction as a positive number).

However, if you had kept the money under your mattress, its purchasing power would decrease by ____ percent.

Answer 1

Like all other goods and services money has its intrinsic value. The value for money is decided by its purchasing power or how much good a unit of money can buy. Lending money for interest increases this purchasing power and inflation decreases the purchasing power of money.

Before the money could have bought 100 units now it buys 102.97 units. Then the purchasing power of money rises by .

• d. As a result of your lending, the purchasing power of your money will increase by __2.97__ percent. If you had not lent your money and instead kept it under your mattress, its purchasing would decrease by __1__ percent (enter this percentage reduction as a positive number).

The price of the good next year would be and the unit money can buy is . Then the purchasing power would have decreased by 0.96%.

• e. Then the purchasing power of your money would decrease by _0.96___ percent. However, if you had kept the money under your mattress, its purchasing power would decrease by __5__ percent.