Rachel agrees to lend Phoebe $100 for six months and charges her interest of 2 percent.At the end of the six-month period, prices have risen by 4 percent.

Question

Quizplus · Accepted Answer

After six months, Phoebe will have to return $102 to Rachel (original $100 plus 2% interest). However, due to the 4% increase in prices, the $102 will only have the purchasing power of $98.08 (100/1.04). This means that Phoebe has effectively lost purchasing power, and that purchasing power has been redistributed to Rachel.

Rachel Agrees to Lend Phoebe $100 for Six Months and Charges