Question

You loaned $100 to a friend for one year at a nominal rate of interest of 5 percent. Inflation during that year was 8 percent. How much did the purchasing power of your money change (an increase is positive and a decrease is negative)?

A) increase by around 3 percent.
B) decrease by around 3 percent.
C) increase by around 13 percent.
D) decrease by around 13 percent.

Answer 1

The purchasing power of your money d. decreased by around 13 percent.

Step-by-step explanation:

The purchasing power of your money d. decreased by around 13 percent.

When inflation occurs, the value of money decreases over time. In this case, the inflation rate of 8 percent means that the prices of goods increased by 8 percent. However, your friend only paid you a nominal rate of interest of 5 percent, so the increase in your money did not keep up with the increase in prices. As a result, the purchasing power of your money decreased by around 13 percent.