Question

You borrowed $1500 from a friend last year and promised to pay him at a 2.0% annual real interest rate. Over the year, inflation turns out to be 1.5%. The amount of money you owe your friend this year is:

a. $1500
b. $1530
c. $1470
d. $1515

Answer 1

The total amount owed on a loan after one year with a 2.0% annual real interest rate and an inflation rate of 1.5% is $1530. The real interest calculation inherently adjusts for inflation, so there's no need for further alterations to the amount based on the inflation rate. correct option is B.

Step-by-step explanation:

The student asked about calculating the amount owed on a loan which has a 2.0% annual real interest rate, with an inflation rate of 1.5%. To find the total amount owed, we need to factor in both the real interest rate and the inflation rate.

To calculate the amount owed after one year, we can use the formula for the adjustment with inflation: Amount owed = Principal + (Principal × Real interest rate). The principal is the original amount borrowed, which in this case is $1500.

First, we calculate the real interest for the year: $1500 × 2.0% = $30. Therefore, the total amount owed without considering inflation would be $1500 + $30 = $1530.

However, because we are looking for the amount in today's dollars and considering the inflation rate, we realize that the real value of the money borrowed has decreased due to inflation. But since we already have the real interest rate, which inherently adjusts for inflation, we do not need to further adjust the amount owed. Thus, the correct answer is $1530, as the real interest rate already accounts for inflation.