Final answer:
The difference between the nominal discount rate and the real discount rate is the inflation rate. The real discount rate is calculated by subtracting the inflation rate from the nominal rate, impacting the true cost of borrowing.
Step-by-step explanation:
The difference between the nominal discount rate and the real discount rate is A) The inflation rate. The real interest rate is the nominal interest rate minus the inflation rate. For instance, if the nominal interest rate is 7% and if the inflation rate is 3%, then the borrower is effectively paying a 4% real interest rate. This distinction is significant because it affects the actual earning power and cost of borrowing. Taxes can further complicate the issue since they are levied on the nominal gain without taking inflation into account.
For example, a person investing $10,000 with a 5% nominal interest rate will be taxed on the $500 received regardless of the inflation rate. If the inflation is high, the investor's real gains could be minimal or negative, yet they still owe taxes on the nominal gain, which can erode the real value of their investment or savings.