Consider the following information about real project rates of return and real T

Question

Consider the following information about real project rates of return and real T-bill interest rates in Rounds 1 and 2. Borrower Nominal Rate of Nominal Rate of Real Rate of Return on Projects in Round 1 and Round 2 (%) Return on ProjectReturn on Project in Round 1 (%) in Round 2 (96) Ayon Barb Carlos Darius Ellen Fay Grace Habeeb Ida Jack 8.6 7.8 7.0 6.2 5.4 4.6 3.8 3.0 2.2 1.4 13.8 13.0 12.2 11.4 10.6 9.8 9.0 8.2 7.4 6.6 7.8 7.0 6.2 5.4 4.6 3.8 3.0 2.2 1.4 0.6 Round 1 Round 2 Nominal T-bill Interest Rate Inlation Rate Real T-bill Interest Rate 4.8% 0.8% 4.0% 7.0% 6.0% 1.0%

Explanation / Answer

Because a project produces the same physical quantity of goods in both rounds, but in the round with the higher inflation rate, the prices of these goods rise faster, which lead to highaer nominal return on the projects at the higher inflation rate of Round 2 even though the real return on the projects stay constant between rounds.

So, the correct answer is an option (C).

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