Question

Suppose the price level today is 0.75, with the base year of 2010.

a. What was the price level in 2010?

b. Has there been inflation or deflation since 2010, and why?

c. Suppose the price level doubles over the course of the next year. What is the price level at the end of next year, and what is the inflation rate?

d. Based on (c), what is your real rate of return if you make an investment with a 50% nominal return?

e. A pair of Jordans cost $100 in 2010, $120 today, and $150 next year. Convert these three prices to real prices in terms of 2010 dollars.

Answer 1

a) Price this year = $0.75

Price in base year or year 2010 must be $1

b) There has been deflation from 2010 because of fall in average price level.

c) If price level doubles over the year, price next year would be $0.75 * 2 = $1.5

Inflation in one year = 100%

d) If nominal interest rate = 50%

Real Interest rate = Nominal interest rate - Inflation rate

Real interest rate = 50% - 100% = -50%

e) Real price in 2010 = $100

Real price today = (Base year price / Current year price) * 100 = (100 / 120) * 100 = 83.33

Real price one year from now = [(Base year price / Price one year from now) * 100] = [(100 / 150) * 100] = 66.67

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