Question

Table 24-4 Bill's expenditures on food for three consecutive years, along with other values, are presented in the following table. ​

	Year
	1	2	3
Expenditures on food	$5,500	$6,300	$6,850
Consumer price index	145	153	x

Refer to Table 24-4. Suppose Will's Year 1 food expenditures in Year 3 dollars amounted to $7,820. Suppose also that the real interest rate in Year 3 was 9 percent. Then, in Year 3,

a. the inflation rate was 35 percent and the nominal interest rate was 44 percent.

b. the inflation rate was 44 percent and the nominal interest rate was 26 percent.

c. the inflation rate was 44 percent and the nominal interest rate was 35 percent.

d. the inflation rate was 35 percent and the nominal interest rate was 26 percent.

Please explain how you got the answer!

Answer 1

Year 1 food expenditure in year 3 dollars = Year 1 food expenditure * (CPI in year 3 / CPI in year 1)

$7820 = $5500 * (CPI in year 3 / 145)

CPI in year 3 = ($7820 * 145) / $5500

CPI in year 3 = 206.16

Inflation rate in Year 3 = [(CPI in year 3 - CPI in year 2) / CPI in year 2] * 100

Inflation rate in Year 3 = [(206.16 - 153) / 153] * 100

Inflation rate in year 3 = 34.74%

Inflation rate in year 3 = 35%

Real interest rate = Nominal interest rate - Inflation rate

9% = Nominal interest rate - 35%

Nominal interest rate = 9% + 35%

Nominal interest rate = 44%

Answer: Option (A)

i.e., inflation rate is 35% and nominal interest rate is 44%