Question

In which case below does a person’s purchasing power from saving increase the most? a. the nominal interest rate = 10% and inflation = 8% b. the nominal interest rate = 9% and inflation = 6% c. the nominal interest rate = 8% and inflation = 4% d. the nominal interest rate = 7% and inflation = 2%

Answer 1

Answer:

The correct answer is option d.

Explanation:

A person earns interest on saving. The increase in the purchasing power is equal to the real interest rate of the savings. Real interest rate is the inflation adjusted interest rate. It is calculated by deducting the rate of inflation from the nominal interest rate.

a. The nominal interest rate = 10% and inflation = 8%

Real interest rate

= Nominal interest rate - Inflation rate

= 10% -  8%

= 2%

b. The nominal interest rate = 9% and inflation = 6%

Real interest rate

= Nominal interest rate - Inflation rate

= 9% -  6%

= 3%

c. The nominal interest rate = 8% and inflation = 4%

Real interest rate

= Nominal interest rate - Inflation rate

= 8% -  4%

= 4%

d.  The nominal interest rate = 7% and inflation = 2%

Real interest rate

= Nominal interest rate - Inflation rate

= 7% -  2%

= 5%

Since the real interest rate is highest in case of option d, it is the correct answer.