Let: (1)Pt be the price of one unit of a market basket of goods (i.e.,a composite commodity)in year t; (2)P^et₊₁ be the expected price of one unit of a market basket of goods in year t + 1; (3)π^et₊₁ be the expected rate of inflation between period t and t + 1; and (4)it be the one-year nominal interest rate.Suppose an individual borrows the equivalent of one unit of a composite commodity today.Given this information,which of the following expressions represents (i.e.,is equal to)the amount of the composite commodity one must repay in one year? A)(1 + it)(P^et₊₁)/ (Pt) B)(1 + π^et₊₁)/ (1 + it) C){(1 + π^et₊₁)/ (1 + it)} - 1 D){(1 + it)(Pt)/ (P^et₊₁)} - 1 E) none of the above

Question

Quizplus · Accepted Answer

The amount of the composite commodity one must repay in one year can be found by multiplying the amount borrowed (which is one unit of the composite commodity) by the price level in the future year, adjusted for inflation and interest. Using the formula for the future price level (P^et₊₁) and nominal interest rate (it), we can rewrite this as: Amount to repay = (1 unit of composite commodity) x (P^et₊₁/Pt) x (1 + it) Therefore, the expression that represents the amount of the composite commodity one must repay in one year is (1 + it)(P^et₊₁)/ (Pt), which is choice A.

Let: (1)Pt Be the Price of One Unit of a Market