alph puts money in the bank and earms a 5 percent nominal interest rate for one

ID: 333476 • Letter: A

Question

alph puts money in the bank and earms a 5 percent nominal interest rate for one year. If the inflation rate is 3 percent, then at the end of the year

a. Ralph will have 5 percent more money in the bank, which will purchase 8 percent more goods

b. Ralph will have 5 percent more money in the bank, which will purchase 2 percent more goods

c. Ralph will have 3 percent more money in the bank, which will purchase 2 percent more goods

d. Ralph will have 3 percent more money in the bank, which will purchase 8 percent more goods

Correct answer is b)

Ralph will have 5% more money in the bank which will purchase 2% more goods.

This is because the relationship between inflation and the nominal rate of interest of the bank is given by the following expression

R = n-i

Where n is the nominal rate and I is the inflation, applying this in the above problem we get:

R = 5-3 2%

Hence for 5% nominal rate, Ralph can purchase 2% of additional goods.

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