Question

To a potential borrower, which would be more important ,the nominal interest rate or the real interest rate? Explain your answer. What does inflation look like in a country that imposes and maintains price ceilings on goods and services?

Answer 1

Ans: To a potential borrower, the real interest rate matters because the real interest rates are adjusted for inflation. the formula for real interest rates is given below:

Real interest rate = Nominal interest rate - inflation rate

If the inflation rate is increasing, then real interest rate falls, it means the real cost of borrowing falls. In this case, the borrower will be better off and lender will be worse off.

The price ceiling means setting up a price maximum. In this price law, the government sets the maximum price of essential commodities so that no seller can charge more than the maximum price. In this case the inflation will be somewhere within the calculation because we know that price level would not go below a certain price level. The inflation can be easily expected. The sellers will be hurt and buyers will be better off.

Whereas, the price floor is a price law in which the government sets the minimum price of goods and services, which means the buyers cannot purchase the good by paying price lower than the minimum price level set by the government. Every seller will charge price which is greater than minimum price level set by the government. In this case, the inflation will be unstable. There are chances that inflation will rise in each period because the sellers now can charge any price more than the minimum price level. The buyers will be hurt and sellers will be better off.