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Click on each question to check your answer.
1. When does inflation occur?
Inflation occurs when money loses purchasing power. That is, when prices are inflated we can buy less with the same amount of money. Inflation makes future dollars less valuable than present dollars. (p. 446)
2. What is the mathematical relationship between the inflation, real interest rate, and market interest rates?
1 + i = (1 + i’) (1 + f) or i = i’ + f + i’f (p. 447)
3. The first is to ignore the effects of inflation in conducting the analysis. The second approach is to systematically include the effects of inflation. (p. 453)
The first is to ignore the effects of inflation in conducting the analysis. The second approach is to systematically include the effects of inflation. (p. 453)
4. Briefly explain how to use the Consumer Price Index to measure inflation.
The Consumer Price Index (CPI) is used to measure how much it costs to maintain a given standard of living defined by Statistics Canada. The base year of the CPI is 100. If CPI goes up, it means more money is required to buy the same amount of goods or services to maintain the given standard of living. This means the cost of living has gone up and the purchasing power of money has gone down, owing to inflation. (p. 459)
5. Is the after–tax nominal interest rate higher than the after–tax real interest rate or not?
After–tax current interest rate is higher than after–tax real interest rate, owing to inflation. (pp. 464-465)