Suppose that you borrow $50,000 from the bank to purchase some land and you agree to pay 2 percent interest on the loan. If the loan must be repaid in 12 months and the inflation rate is 4 percent during the year, then
A) you will repay the bank with dollars with more purchasing power than you initially borrowed.
B) you will repay the bank with fewer dollars than the bank initially loaned you.
C) you will repay the bank with dollars with less purchasing power than it initially loaned you.
D) the bank will receive fewer dollars, because of inflation, than it had initially expected to receive.

Question

Quizplus · Accepted Answer

Inflation reduces the purchasing power of money over time. Therefore, when you repay the loan with dollars at the end of the year, those dollars will be worth less than the dollars you borrowed initially. As a result, you will repay the bank with dollars with less purchasing power than it initially loaned you.

Suppose That You Borrow $50,000 from the Bank to Purchase