Suppose Megan is an avid reader and buys only mystery novels. Megan deposits $3,
ID: 2496259 • Letter: S
Question
Suppose Megan is an avid reader and buys only mystery novels. Megan deposits $3,000 in a bank account that pays an annual nominal interest rate of 10%. Assume this interest rate is fixed—that is, it won't change over time. At the time of her deposit, a mystery novel is priced at $15.00. Initially, the purchasing power of Megan's $3,000 deposit is 200 mystery novels. For each of the annual inflation rates given in the following table, first determine the new price of a mystery novel, assuming it rises at the rate of inflation. Then enter the corresponding purchasing power of Megan'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 mystery novel. For example, if you find that the deposit will cover 20.7 mystery novels, you would round the purchasing power down to 20 mystery novels under the assumption that Megan will not buy seven-tenths of a mystery novel. When the rate of inflation is less than the interest rate on Megan's deposit, the purchasing power of her deposit(rise/fall/stay the same ) over the course of the year.
Annual Inflation Rate 0% 090 10% 1390 Number of Novels Megan Can Purchase after One Year Real Interest RateExplanation / Answer
Real interest rate = Nominal interest rate – Inflation
Nominal interest rate is 10% here.
Table
Annual inflation rate
0%
10%
13%
New price of novel
$15
$15 × (1 + 0.1) = $16.5
$15 × (1 + 0.13) = $16.95
Number of novels
200
(3,000 / 16.5) = 181
(3,000 / 16.95) = 176
Real interest rate
10%
0%
-3%
If the rate of inflation is less than the interest rate of M’s deposit, the purchasing power of her deposit would rise.
Annual inflation rate
0%
10%
13%
New price of novel
$15
$15 × (1 + 0.1) = $16.5
$15 × (1 + 0.13) = $16.95
Number of novels
200
(3,000 / 16.5) = 181
(3,000 / 16.95) = 176
Real interest rate
10%
0%
-3%
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