Suppose Bob Considers Borrowing $100 from Sheila at a 10

question 116

Essay

Suppose Bob considers borrowing $100 from Sheila at a 10 percent interest rate. They both think that a 4 percent real interest rate would be fair.
a.What was the inflation rate they both expected?
b.If the inflation rate turned out to be 8 percent, how much was the real interest rate? Who gained and who lost from this transaction, and how much because of unexpected inflation?
c.If there was a capital gain tax of 30 percent, what is the after-tax real interest rate, with the inflation rate of 8 percent?

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Definitions:

Demand-Side

Economic policies or concepts focused on increasing demand for goods and services as a way to stimulate economic growth.

Market Failures

Situations where the allocation of goods and services by a free market is not efficient, often leading to a net social welfare loss.

Shortage

The amount by which the quantity demanded of a product exceeds the quantity supplied at a particular (below-equilibrium) price.

Market

Any institution or mechanism that brings together buyers (demanders) and sellers (suppliers) of a particular good or service.