W3 tute answers.pdf - ECC1100 S1 2017 Week 3 Tutorial NOTE...

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ECC1100 S1 2017 1 Week 3 Tutorial NOTE: TEST 1 in this tutorial! All the best! 1. Textbook, chapter 1, Problem no 9 on page 43. First, calculate inflation for each year. For 2011, inflation is the percentage increase in the CPI over that year, equal to (108 100)/100 = 8%. For 2012, inflation is (115 108)/108 = 6.5%. For 2013, inflation is (125 115)/115 = 8.7%. Real return equals the nominal interest rate minus the inflation rate. Subtracting the inflation rate for each year from the nominal interest rate (5% in each year) gives real returns of 3% in 2011, 1.5% in 2012, and 2.7% in 2013. Now consider the three-year period as a whole. At the end of one year, Albert’s $1000 is worth $1050. Assuming that interest is re-invested, at the end of two years he has $1050 × 1.05 = $1102.50, and at the end of three years he has $1102.50 × 1.05 = $1157.62, for a total gain of 15.7%. As the price level has risen by 25% over the three years, Albert’s total real return over the three years is 15.7% – 25% = - 9.3%. 2. In your view which is the most important cost of inflation?
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