Suppose that you deposit $100 in a bank account that is paying 5% interest. At the end of the year, your acc?

Question

Suppose that you deposit $100 in a bank account that is paying 5% interest. At the end of the year, your account is worth $105. The inflation rate for the year was 2%.

Another way to understand the concept of real interest rates is to see how inflation affects the purchasing power of money. Suppose you were considering buying a DVD player with the $100, but then decided to deposit the $100 in the bank, where it earned interest at a rate of 5%. If the price of the DVD player increased at the rate of inflation, how much did your purchasing power increase by saving the $100?

%

Please enter a whole number, with no decimal point.

Answer 1

1.05/1.02=1.0294≈+2.94%≈+3%

Answer: purchasing power increased for +3%

Answer 2

5% interest minus 2% inflation  = +3% real return. No rounding required. The answer above incorrectly uses a nominal baseline to calculate a real return.

Using wrong baseline: 3/102 = 2.94%

Using correct baseline: 3/100 = 3.00%

See (1):

[Real Interest Rate = Nominal Interest Rate - Inflation]