Mikey cuts hair to pay for his tuition for college. Unfortunately, the cost of a
ID: 1252870 • Letter: M
Question
Mikey cuts hair to pay for his tuition for college. Unfortunately, the cost of a haircut in his town hasn’t risen in years, and neither has his hourly wage. To make matters worse, the cover charge at his favourite club, Stages, keeps rising. He asks you to lend him $600, promising to repay you with interest at the end of one year. You try to convince him to stay home and do his work, but he doesn’t waiver. You decide to charge Mikey 5% interest, the same as the fixed rate on your student loan. At the end of the year, he repays you principal plus interest in full.
Question:
I know the figures from part a is: 0%
and part b is: -10%
Find the precise expected real rate using the CPI figures from parts (a) and (b) (correct to 2 decimal places ie. 4.75%). What would be the expected real interest rate if you never considered that prices could change during the year?
Explanation / Answer
I'm not sure of your entire question.
What is part (a) and what is part (b)?
According to Fisher equation: i = e + r
i = nominal interest
e = expected inflation
r = real interest rate
Your nominal interest is the interst that you charge, i.e. the interest rate on your "school loan".
expected inflation = 0%, since you do not "expect" prices to change.
So your real interest rate should = nominal interest rate (which is 5% according to your question)
You mentioned CPI figures from parts a & b, however they are not listed in your question.