Answered: Suppose Diamond is a fashionista and…

ENGR.ECONOMIC ANALYSIS

14th Edition

ISBN:9780190931919

Author:NEWNAN

Publisher:NEWNAN

Chapter1: Making Economics Decisions

Section: Chapter Questions

Problem 1QTC

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Interest, inflation, and purchasing power

Suppose Diamond is a fashionista and buys only denim jackets. Diamond deposits $4,000 into a savings account that pays an annual nominal interest rate of 5%. Assume this interest rate is fixed, and so it will not change over time. On the day she makes her deposit, suppose that a denim jacket has a price of $20.00.

Initially, Diamond's $4,000 deposit has a purchasing power of #________ denim jackets.

For each of the annual inflation rates given in the following table, first determine the new price of a denim jacket, assuming it rises at the rate of inflation. Then enter the corresponding purchasing power of Diamond'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 denim jacket. For example, if you find that the deposit will cover 20.7 denim jackets, you would round the purchasing power down to 20 denim jackets under the assumption that Diamond will not buy seven-tenths of a denim jacket.

Annual Inflation Rate

10%

Number of Jackets Diamond Can Purchase after One Year

0% = 100, 200, 210 or 380

5% = 100, 200, 210 or 380

10% = 100, 190, 200, 380

Real Interest Rate

0% = _______%

5% = _______%

10% = ______%

When the rate of inflation is equal to the interest rate on Diamond's deposit, the purchasing power of her deposit FALLs or RISES or REMAINS THE SAME over the course of the year.

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