Question

You have $55,000 in your savings account that pays 2.5% annual interest and the inflation rate is 3.4%. how much buying power in dollars will you lose in one year because of inflation?

Answer 1

Answer;

= $ 682

Solution and explanation;

-We can calculate the buying power loss in three steps.

Step 1 - Interest made in a year.

-Interest in a year = savings amount * interest rate * time

-Interest in a year = $55,000 * 2% * 1 year

-Interest in a year = $1,100

Step 2- Amount needed to be made to keep up with inflation in that year;

-Amount to keep up with inflation = $55,000 * 3.24% * 1 year

-Amount to keep up with inflation = $ 1,782

Step 3- Buying power loss that year;

-Buying power loss = Amount needed to keep up with inflation - interest

-Buying power loss = $1,782 - $1,100

Buying power loss = $682

Answer 2

Your interest formula is given to you.

Interest in a year = principal (the amount invested) * rate (the interest rate) * period (the time you're measuring)

Interest = 55,000 * 2% * 1 year = 55,000 * 0.02 * 1 = $1,100

How much would you need to have made for your spending power to keep with inflation? Your interest rate would have needed to match the inflation rate, otherwise, prices are going up faster than you're saving.

Required interest = 55,000 * 3.24% * 1 year = 55,000 * 0.0324 * 1 = $1,782

How much buying power did you lose? The difference between your required interest and your actual interest.
Buying power lost = 1,782 - 1,100 = $682. You lost this much in buying power.