Initially, Crystal earns a salary of $400 per year, and Charles earns a salary o
ID: 1228173 • Letter: I
Question
Initially, Crystal earns a salary of $400 per year, and Charles earns a salary of $200 per year. Crystal lends Charles $100 for one year at an annual interest rate of 20% with the expectation that the rate of inflation will be 16% during the one-year life of the loan. At the end of the year, Charles makes good on the loan by paying Crystal $120. Consider how the loan repayment affects Crystal and Charles under the following scenarios. Suppose all prices and salaries rise by 16% (as expected) over the course of the year. In the following table, find Crystal's and Charles's new salaries after the 16% increase, and then calculate the $120 payment as a percentage of their new salaries. Remember that Crystal's salary is her income from work and that it does not include the loan payment from Charles.) Consider an unanticipated decrease in the rate of inflation. The rise in prices and salaries turns out to be 5% over the course of the year rather than 16%. In the following table, find Crystal's and Charles's new salaries after the 5% increase, and then calculate the $120 payment as a percentage of their new salaries. An unanticipated decrease in the rate of inflation benefits and harms .Explanation / Answer
answer
SCENARIO - 1
Crystal's new salary = $400 x 1.16 = $464
Payment as % of new salary = $120 / $464 = 0.2586 = 25.86%
Bryan's new salary = $200 x 1.16 = $232
Payment as % of new salary = $120 / $232 = 0.5172 = 51.72%
SCENARIO - 2
Crystal's new salary = $400 x 1.05 = $420
Payment as % of new salary = $120 / $420 = 0.2857 = 28.57%
Bryan's new salary = $200 x 1.05 = $210
Payment as % of new salary = $120 / $210 = 0.5714 = 57.14%
So,
Unanticipated decrease in inflation rate benefits Lenders and harms Borrowers.