Question

Is an avid reader and buys only mystery novels. Janet deposits $3,000 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 or her deposit, a mystery Initially, the purchasing power of Janet's $3,000 deposit smystery novels For each of the annual inflation rates given in the following table, first determine the new price of a mystery novel, assuming it rises at the rate of Inflation. Then enter the corresponding purchasing power of Janet'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 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 Janet will not buy seven-tenths of a mystery novel. Annual Inflation Rate 0% 5% 8% Number of Novels Janet Can Purchase after One Year Real Interest Rate When the rate of inflation is greater than the interest rate on Janet's deposit, the purchasing power of her deposit course of the year over the

Answer 1

We have the following information

Inflation Rate	Nominal Interest Rate	Real Interest Rate	Deposit Amount ($)	Future Value of Deposit ($)	Price of Novel ($)	Number of Novels that can be Purchased
0%	5%	5%	3,000	3,000	15.00	200
5%	5%	0%	3,000	3,150	15.75	200
8%	5%	-3%	3,000	3,240	17.01	190

Real Interest Rate = Nominal Interest Rate – Inflation Rate

Future Value = Present Value(1 + i)ⁿ; where i is the nominal interest rate (8%), n is the number of years which in present case is 1 year, and Present Value is the deposit amount of $3,000.

From the table we can see that, when the rate of inflation is greater than the nominal interest rate on Janet’s deposit, the purchasing power of her deposit declined over the course of the year from 200 novels to 190 novels.