Over the past year you earned a nominal rate of interest of 8 percent on your money.The inflation rate was 4 percent over the same period.The exact actual growth rate of your purchasing power was
A)15.5%.
B)10.0%.
C)3.8%.
D)4.8%.
E)15.0%.

Question

Quizplus · Accepted Answer

The real interest rate is calculated by subtracting the inflation rate from the nominal interest rate. In this case, the real interest rate is 8% - 4% = 4%.

The actual growth rate of purchasing power is then calculated by adding 1 to the real interest rate, and multiplying by the starting value of purchasing power. That is, (1 + real interest rate) x starting value of purchasing power.

So, (1 + 0.04) x 1 = 1.04.

Therefore, the actual growth rate of purchasing power was 4%. However, since the question asks for the exact growth rate, the correct answer is C) 3.8%, which is (1 + 0.04)/(1 + 0.08) - 1, or the difference between the growth rate of the purchasing power and the nominal interest rate.

Over the Past Year You Earned a Nominal Rate of Interest