Suppose Madeline is an avid reader and buys only mystery novels. Madeline deposi

Question

Suppose Madeline is an avid reader and buys only mystery novels. Madeline deposits $2,000 in a bank account that pays an annual interest rate of 20%. You can assume that 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 $10.00. Initially, the purchasing power of Madeline's $2,000 deposit is mystery novels. The price of a mystery novel rises at the rate of inflation. For each of the annual inflation rates in the following table, select the corresponding purchasing power of Madeline's deposit after one year, and enter the value for the real interest rate. Hint: Round your answers 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 Madeline will not buy seven-tenths of a mystery novel. When the rate of inflation is greater than the interest rate on Madeline's deposit, the purchasing power of her deposit over the course of the year.

Explanation / Answer

initial 200

at 0% it is 240 novels;real Interst rate : 20 - 0 = 20%

at 20% it is 2400/12 = 200 noves ; real interest rate : 20 - 20 = 0%

at 22% it is 2400/12.5 = 192 novels ; real interest rate : 20 - 22 = -2%

purchasing power falls

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