Suppose Lucia is a sports fan and buys only baseball caps. Lucia deposits $3,000

Question

Suppose Lucia is a sports fan and buys only baseball caps. Lucia deposits $3,000 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 baseball cap is priced at $10.00. Initially, the purchasing power of Lucia's $3,000 deposit is baseball caps. For each of the annual inflation rates given in the following table, first determine the new price of a baseball cap, assuming it rises at the rate of inflation. Then enter the corresponding purchasing power of Lucia'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.

Explanation / Answer

1) 300 caps ( 3000/10)

300         300        290

   5%          0%         -3%

Here real intrest rates must be calculated by formula

Real intrest rates = Nominal intrest rates - Inflation

Decreases

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