Question

5. Interest, inflation, and purchasing power Suppose Neha is a cinephile and buys only movie tickets. Neha deposits $2,000 in a bank account that pays an annual nominal interest rate of 5%. Assume this interest rate is fixed—that is, it won't change over time. At the time of her deposit, a movie ticket is priced at $20.00. Initially, the purchasing power of Neha's $2,000 deposit is movie tickets. For each of the annual inflation rates given in the following table, first determine the new price of a movie ticket, assuming it rises at the rate of inflation. Then enter the corresponding purchasing power of Neha'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 movie ticket. For example, if you find that the deposit will cover 20.7 movie tickets, you would round the purchasing power down to 20 movie tickets under the assumption that Neha will not buy seven-tenths of a movie ticket. Annual Inflation Rate 0% 5% 8% Number of Tickets Neha Can Purchase after One Year Real Interest Rate % % % When the rate of inflation is less than the interest rate on Neha's deposit, the purchasing power of her deposit over the course of the year.

Answer 1

At first, the purchasing power of Ginny's 2000 deposit is:

Initial deposit/Price

=2000/20

=100 movie tickets

Annual inflation rate	0%	5%	10%
Number of tickets Ginny can purchase after one year	105	100	95
Real interest rate	5%	0%	-5%

• When there is no inflation,the price of a movie ticket would be 20 following a year and the deposit will increment to 2000*(1+0.05) = 2100

Purchasing power = 2100/20 = 105

Real interest rate = Nominal - inflation = 5-0 = 5%

• When the inflation is 5%,the price would increment to 20*(1+0.05) = 21

Purchasing power = 2100/21 = 100

Real interest rate = 5-5=0%

- When the inflation is 10%,the price would increment to 20*(1+0.10) = 22

Purchasing power = 2100/22 = 95

Real interest rate = 5-10=-5%

At the point when the rate of inflation is more noteworthy than the interest rate on Ginny's deposit the purchasing power of her deposit FALLS through the span of the year.

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