Question

19. Manny becomes a manager at a hardware store in 1990 at a salary of $30,000. By 2013, he has been promoted to district manager with a salary of $50,000. Suppose the price index in 1990 is 112 and the price index in 2013 is 184. Which of the following statements is (are) correct?
A. Manny's 2013 salary in 1990 dollars is more than $30,000, but less than $30,500.
B. Manny’s 1990 salary in 2013 dollars is more than $48,600, but less than $49,200
C. Between 1990 and 2013, the purchasing power of Manny's salary has increased
D. All of the above
E. A and C, only

20. Which of the following statements is (are) correct?
(x) Nominal interest rates are lower than real interest rates if deflation exists and real rates are lower than nominal rates in inflation exists.
(y) If borrowers and lenders agree on a nominal interest rate and inflation turns out to be more than they had expected, then borrowers will gain at the expense of lenders.
(z) Helen buys a house in 2018 and finances it with a mortgage that carries an annual interest rate of 4.5 percent. If inflation in 2018 is 2 percent, then Helen is paying a real interest rate of 6.5 percent.
A. (x), (y) and (z)
B. (x) and (y) only
C. (x) and (z) only
D. (y) and (z) only
E. (y) only

Answer 1

19) Salary in 1990 = $30,000

Salary in 2013 = $50,000

CPI in 1990 = 112

CPI in 2013 = 184

Manny's salary in 2013 in 1990 dollars = (112 / 184) * 50,000 = 30,434.78. Thus option A is correct.

Manny's salary in 1990 in 2013 dollars = (184 / 112) * 30,000 = 49,285.71. Thus option B is incorrect.

If we calculate the change in CPI which is 184 / 112 =1.64. It means CPI becomes 1.64 in 2013 and Salary should also be 1.64 times if there is no change in purchasing power. As salary is 30,000 * 1.64 = 49,285.71 more than this, there is rise in purchasing power.

Option E is correct.

20) Nominal interest rate = Inflation rate + Real interest rate

Option X is correct as if there is inflation, real rate is less than nominal interest rate while vice versa is also true.

Option Y is correct, as inflation benefits borrowers as they have to pay money which have less purchasing power or they have to pay money back which have less real value.

Nominal interest rate = 4.5% and inflation rate = 2% then real interest rate = 4.5% - 2% = 2.5%. Thus this option is incorrect.

Option B is correct.