5. Interest, inflation, and purchasing power Suppose Ginny is a cinephile and bu
ID: 1118865 • Letter: 5
Question
5. Interest, inflation, and purchasing power
Suppose Ginny is a cinephile and buys only movie tickets. Ginny deposits $4,000 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 movie ticket is priced at $10.00.
Initially, the purchasing power of Ginny's $4,000 deposit ismovie tickets.
For each of the annual inflation rates given in the following table, first determine the new price of a movie ticket, assuming it rises at the rate of inflation. Then enter the corresponding purchasing power of Ginny'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 movie ticket. For example, if you find that the deposit will cover 20.7 movie tickets, you would round the purchasing power down to 20 movie tickets under the assumption that Ginny will not buy seven-tenths of a movie ticket.
Annual Inflation Rate
When the rate of inflation is equal to the interest rate on Ginny's deposit, the purchasing power of her depositremains the same over the course of the year.
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Annual Inflation Rate
0% 5% 8% Number of Tickets Ginny Can Purchase after One Year Real Interest RateExplanation / Answer
Initially the purchasing power is 400 tickets.
If there is no inflation rate then the amount of $4,000 will become $4,200 after 1 year. Because price of the movie ticket will remain unchanged at $10, number of tickets Guinny can purchase after one year when annual inflation is 0% is 420. Real interest rate is equals to nominal interest rate - rate of inflation. Since rate of inflation is zero really interested in this case is 5%.
With an annual inflation rate of 5% the real interest rate is 0%. The deposit will now become $4,200 and the price of movie ticket will increase to reach $10.50. the number of tickets Ginni can purchase after one year one year when the annual inflation rate is 5% is 400
When the inflation rate is 8% the real interest rate is - 3%. Price of movie tickets will now increase to $10.80. the number of tickets now become 388.
It is true that when the rate of inflation is equal to the rate of interest on deposit the purchasing power does not change.
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