Question

Ms. Lane borrowed $1,000 from her bank for one year at an interest rate of 10 percent. During that year, the price level went up by 15 percent. Which of the following statements is correct?

Answer 1

Answer:

Consider the complete question is,

'Ms. Lane borrowed $1,000 from her bank for one year at an interest rate of 10 percent. During that year, the price level went up by 15 percent. Which of the following statements is correct?

a. Ms. Lane will repay the bank fewer dollars than she initially borrowed.

b. Ms. Lane's repayment will give the bank less purchasing power than it originally loaned her.

c. Ms. Lane's repayment will give the bank greater purchasing power than it originally loaned her.

d. Ms. Lane's repayment will give the bank the same purchasing power that it originally loaned her.'  

Solution :

We have,

The borrowed amount, P = $ 1,000,

Interest rate, r = 10% = 0.1,

Time, t = 1 year,

Thus, the returned amount,

$A=P(1+r)^t=1000(1+0.1)^1=1000(1.1) = \ 1100$

∵ A > P

⇒ Ms. Lane will repay the bank greater dollars than she initially borrowed.

Now,  the price level went up by 15 percent,

∵ 1000 + 15% of 1000 = 1000 + 150 = 1500

And, 1500 > 1100

⇒ Ms. Lane's repayment will give the bank less purchasing power than it originally loaned her.