Question

1. Jim borrows 100 bushels of wheat and must repay 105 bushels of wheat in one year. What is the interest rate and what type of interest rate is it?

2. Jim borrows $100 and must repay $105 in one year. What is the interest rate and what type of interest rate is it?

3. Jim borrows $100 in 2012 when the price of wheat is $10. He must repay $110 in 2013. The price of wheat in 2013 is $11.

a. What is the inflation rate?

b. What is the nominal interest rate?

c. What is the real interest rate (Hint: How much wheat does he borrow and how much does he repay?)

d. What nominal interest rate would make the real interest rate identical to that in number 1 above?

4. The following is Jim’s production function for wheat.

I               1              2              3              4              5              6              7              8              9              10

TP           2              3.7          5.2          6.6          7.9          9.15        10.35     11.5        12.6        13.65

a. What is Jim’s demand for loanable wheat as a function of the real interest rate?

b. What is Jim’s demand for loanable funds, as a function of the nominal interest rate, if the price of wheat is $10 today and will be $10 next year?

c. What is Jim’s demand for loanable funds, as a function of the nominal interest rate if the price of wheat is $10 today and will be $11 next year?

Answer 1

1) Amount borrowed = 100 bushels of wheat

Amount to be repaid = 105 bushels of wheat

Interest rate = ((105/100)-1)*100

Interest rate = (1.05-1)*100 = 5%

It is a simple interest rate

2)

Amount borrowed = $100

Amount to be paid = $105

Interest rate = ((105/100)-1)*100

Interest rate = 5%

It is simple interest rate

3)

CPI = (current market price / base market price )*100

Base market price = price of 2012 = $100

CPI in 2012 =( 100/100) *100 = 100

CPI in 2013 = (110/100)*100 = 110

a)Inflation rate = ((110-100)/100)*100 = 10%

b)Nomina interest rate = ((110/100)-1)*100

Nominal interest rate = (1.1-1)*100 = 10%

C)Real interest rate = Nominal interest rate - inflation rate

Real interest rate = 10-10 = 0