Suppose that a person earns $75,000 now and anticipates a 4% raise next year. The current...
Suppose that a person earns $75,000 now and anticipates a 4% raise next year. The current nominal interest rate on savings is 5%. Prices are also expected to rise 2% next year.
In real terms, how much can the person consume next year in real terms if they currently spend $65,000 on goods & services?
*The answer is not $66,176.47
Homework Answers
Current Consumption = $ 65000, Nominal Interest Rate = 5 % and Inflation Rate = Rate of Rise in Prices = 2 %
Therefore, Real Interest Rate = [(1+Nominal Interest Rate) / (1+Inflation Rate)] - 1 = [(1.05)/(1.02)] - 1 = 0.02941 or 2.941 %
Real Consumption Next Year = 65000 x (1.0241) = $ 66911.76
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