Initially, Eleanor earns a salary of $200 per year and Darnell earns a salary of

ID: 2734965 • Letter: I

Question

Initially, Eleanor earns a salary of $200 per year and Darnell earns a salary of $100 per year. Eleanor lends Darnell $50 for one year at an annual interest rate of 16% with the expectation that the rate of inflation will be 5% during the one-year life of the loan. At the end of the year, Darnell makes good on the loan by paying Eleanor $58. Consider how the loan repayment affects Eleanor and Darnell under the following scenarios. Scenario 1: Suppose all prices and salaries rise by 5% (as expected) over the course of the year. In the following table, find Eleanor's and Darnell's new salaries after the 5% increase, and then calculate the $58 payment as a percentage of their new salaries. (Hint: Remember that Eleanor's salary is her income from work and that it does not include the loan payment from Darnell.) Value of Eleanor's new salary after one year The $58 payment as a percentage of Eleanor's new salary Value of Darnell's new salary after one year The $58 payment as a percentage of Darnell's new salary Scenario 2: Consider an unanticipated increase in the rate of inflation. The rise in prices and salaries turns out to be 14% over the course of the year rather than 5%. In the following table, find Eleanor's and Darnell's new salaries after the 14% increase, and then calculate the $58 payment as a percentage of their new salaries. Value of Eleanor's new salary after one year The $58 payment as a percentage of Eleanor's new salary Value of Darnell's new salary after one year The $58 payment as a percentage of Darnell's new salary An unanticipated increase in the rate of inflation benefits______ and harms_____ .

Explanation / Answer

Scenario 1

Scenario 2

after the 5% increase

after the 14% increase

Eleanor's salaries

200

Darnell's salaries

100

Eleanor's new salaries

210

228

Darnell's new salaries

105

114

the $58 payment as a percentage of Eleanor’s new salaries

27.62

25.44

the $58 payment as a percentage of Darnell’s new salaries

55.24

50.88

An unanticipated increase in the rate of inflation benefits Darnell as his loan payment amount as percentage of total income has reduced and it harms Eleanor as her income from loan as the percent of total income has reduced.