Let’s assume that the old clunker you have been driving needs $500 in repairs in order to pass an annual car inspection. You are
considering buying a new car, and you contact car dealers and banks to determine the best deal you can get on a car loan. Assume two different scenarios: (a) The lowest interest rate you find on a five-year car loan is 10 percent, and the annual rate of inflation for the next five years will be 9 percent. (b) The lowest interest rate you can find on a five-year car loan is 6 percent, and the annual rate of inflation for the next five years will be 1 percent. Question: Under which scenario—(a) or (b)—will you pay less, in real income, for your car loan?
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