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7. Unanticipated changes in the rate of inflation Initially, Dina earns a salary of $400 per...

7. Unanticipated changes in the rate of inflation

Initially, Dina earns a salary of $400 per year and Charles earns a salary of $200 per year. Dina lends Charles $100 for one year at an annual interest rate of 10% with the expectation that the rate of inflation will be 5% during the one-year life of the loan. At the end of the year, Charles makes good on the loan by paying Dina $110. Consider how the loan repayment affects Dina and Charles under the following scenarios.

Scenario 1: Suppose all prices and salaries rise by 5% (as expected) over the course of the year. In the following table, find Dina's and Charles's new salaries after the 5% increase, and then calculate the $110 payment as a percentage of their new salaries. (Hint: Remember that Dina's salary is her income from work and that it does not include the loan payment from Charles.)

Value of Dina's new salary after one year

The $110 payment as a percentage of Dina's new salary

Value of Charles's new salary after one year

The $110 payment as a percentage of Charles's new salary
                       

Scenario 2: Consider an unanticipated increase in the rate of inflation. The rise in prices and salaries turns out to be 20% over the course of the year rather than 5%. In the following table, find Dina's and Charles's new salaries after the 20% increase, and then calculate the $110 payment as a percentage of their new salaries.

Value of Dina's new salary after one year

The $110 payment as a percentage of Dina's new salary

Value of Charles's new salary after one year

The $110 payment as a percentage of Charles's new salary
                       

An unanticipated increase in the rate of inflation benefits   and harms   .

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