Question

Mary expects the inflation rate to be 5%, and she is willing to pay a real interest rate of 3%. Joe expects the inflation rate to be 5%, and he is willing to lend money if he receives a real interest rate of 3%. If the actual inflation rate is 6% and the loan contract specifies a nominal interest rate of 8%, then:
a)Joe is glad he lent out funds even though his real interest rate has fallen.
b)Joe is sorry he lent out funds since his real interest rate is now 9%.
c)Mary is glad she borrowed the funds because her real interest rate has fallen.
d)Mary is sorry she borrowed funds since her real interest rate is now 9%.

Answer 1

Answer:

c)Mary is glad she borrowed the funds because her real interest rate has fallen.

Explanation:

Real interest rate = nominal interest rate - inflation rate

=8% - 6% = 2%

Mary is willing to pay a real interest rate of 3% but she pays 2%. Her consumer surplus is 1%

Joe is willing to accept 3% but receives 2% in the end. Therefore, he doesn't earn a producer surplus.

I hope my answer helps you