Question

Gina has a money market savings account at Bank of America which earns her 7.0 percent interest per year. One year later, Gina withdraws her money and closes the account. During the year, prices rose 4 percent. Gina earned a nominal interest rate of

a) 7 percent and a real interest rate of 11 percent.

b) 7 percent and a real interest rate of 3 percent.

c) 11 percent and a real interest rate of 7 percent

d) 11 percent and a real interest rate of 3 percent

Answer 1

The interest rate that one earns on a saving account is a nominal interest rate. Here she is earning 7% on her saving account. Thus, Gina earned a nominal interest rate of 7%.

Formula:

Real interest rate = Nominal interest rate - inflation rate.

Here, Nominal interest rate = 7% and inflation rate = % increase in price = 4%  

Thus Real interest rate = 7% - 4% = 3%.

Thus, Gina earned a Real interest rate of 3%.

Hence, the correct answer is (b) 7 percent and a real interest rate of 3 percent.