Suppose that you lend me $100 for a year,and that I agree to pay you $110 at the end of one year (principal plus interest).Over the intervening year,however,the average price of goods in the economy rises by 3%.The real rate of return that you will earn on your loan to me is therefore equal to

Question

Quizplus · Accepted Answer

The nominal interest rate on the loan is 10% ($110 - $100 = $10 of interest). However, due to the inflation rate of 3%, the purchasing power of that $110 in one year will be equivalent to $110 / 1.03 = $106.80 in today's dollars.

The real rate of return on the loan is therefore ($106.80 - $100) / $100 = 6.8%, which when rounded to the nearest whole number is equal to 7%.

Therefore, the correct choice is B.

Suppose That You Lend Me $100 for a Year,and That