Question

Suppose Ginny is a cinephile and buys only movie tickets. Ginny deposits $2,000 in a bank account that pays an annual nominal interest rate of 15%. Assume this interest rate is fixed—that is, it won't change over time. At the time of her deposit, a movie ticket is priced at $20.00.

Initially, the purchasing power of Ginny's $2,000 deposit ismovie tickets.

For each of the annual inflation rates given in the following table, first determine the new price of a movie ticket, assuming it rises at the rate of inflation. Then enter the corresponding purchasing power of Ginny's deposit after one year in the first row of the table for each inflation rate. Finally, enter the value for the real interest rate at each of the given inflation rates.

Hint: Round your answers in the first row down to the nearest movie ticket. For example, if you find that the deposit will cover 20.7 movie tickets, you would round the purchasing power down to 20 movie tickets under the assumption that Ginny will not buy seven-tenths of a movie ticket.

	Annual Inflation Rate
	0%	15%	18%
Number of Tickets Ginny Can Purchase after One Year
Real Interest Rate

When the rate of inflation is greater than the interest rate on Ginny's deposit, the purchasing power of her deposit( falls, rises, remains) over the course of the year.

Answer 1

1. No. of tickets that Ginny can buy from 2000 = $ 2000/$ 20 = 100 tickets

2. When inflation rate is 0%:

Number of Tickets Ginny Can Purchase after One Year = 2000/20 = 100 tickets

Real interest rate = Nominal interest rate - Inflation rate = 15% - 0% = 15%

When inflation rate is 15%:

Price of movie ticket after inflation = 20 + 15% of 20 = 20 + 3 = 23

Number of Tickets Ginny Can Purchase after One Year = 2000/23 = 87 tickets

Real interest rate = Nominal interest rate - Inflation rate = 15% - 15% = 0%

When inflation rate is 18%:

Price of movie ticket after inflation = 20 + 18% of 20 = 20 + 3.6 = 23.6

Number of Tickets Ginny Can Purchase after One Year = 2000/23.6 = 85 tickets

Real interest rate = Nominal interest rate - Inflation rate = 15% - 18% = - 3%

Value of her deposit Falls over the course of the year.