7 Unanticipated changes in the rate of inflation raded Assi

7. Unanticipated changes in the rate of inflation .

raded Assignment Attempts: Average: 7. Unanticipated changes in the rate of inflation Initially, Cho earns a salary of $200 per year and Bob earns a salary of $100 per year. Cho lends Bob $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, Bob makes good on the loan by paying Cho $58. Consider how the loan repayment affects Cho and Bob under the following scenarios. Scenario 1: Suppose all prices and salaris rise by 5% as expected over the course of the year. In the following table, find ges and Bob\'s new salaries after the 5% increase and then calculate the $58 payment as a percentage of ther new salaries (Hint: Remember that hos salary is her income from work and that it does not indlude the loan payment from Bob.) Value of Cho\'s new salaryThe $58 payment as a percentage Value of Bob\'s new salary The $58 payment as a percentage after one year of Cho\'s new salary after one year of Bob\'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 Cho\'s and Bob\'s new salaries after the 14% increase, and then calculate the $58 payment as a percentage of their new salaries. Value of Cho\'s new salary after one year The $58 payment as a percentage of Cho\'Oew salary Value of Bob\'s new salary after one year The $58 payment as a percentage of Bob\'s new salary and harms An unanticipated increase in the rate of inflation benefits B Save & Continise Contnue without saveng

Solution

Scenario 1

Salary of Cho = $200

Percentage increase in salary = 5% or 0.05

Calculate the new salary of Cho after one year -

New salary = Old salary + Increase

New salary = $200 + ($200 * 0.05) = $200 + $10 = $210

Calculate $58 payment as a percentage of Cho\'s new salary -

Percentage = ($58/$210) * 100 = 27.62%

Salary of Bob = $100

Percentage increase in salary = 5% or 0.05

Calculate the new salary of Bob after one year -

New salary = Old salary + Increase

New salary = $100 + ($100 * 0.05) = $100 + $5 = $105

Calculate $58 payment as a percentage of Bob\'s new salary -

Percentage = ($58/$105) * 100 = 55.24%

Following is the complete table -

Scenario 2

Salary of Cho = $200

Percentage increase in salary = 14% or 0.14

Calculate the new salary of Cho after one year -

New salary = Old salary + Increase

New salary = $200 + ($200 * 0.14) = $200 + $28 = $228

Calculate $58 payment as a percentage of Cho\'s new salary -

Percentage = ($58/$228) * 100 = 25.43%

Salary of Bob = $100

Percentage increase in salary = 14% or 0.14

Calculate the new salary of Bob after one year -

New salary = Old salary + Increase

New salary = $100 + ($100 * 0.14) = $100 + $14 = $114

Calculate $58 payment as a percentage of Bob\'s new salary -

Percentage = ($58/$114) * 100 = 50.88%

Following is the complete table -

Unanticipated increase in inflation rate always benefit borrowers and hurt creditors as real value of money to be paid back decreases providing benefit to borrowers while hurting creditors.

In this case, Bob is borrower while Cho is creditor.

So,

An unanticipated increase in the rate of inflation benefit Bob and harms Cho.

Value of Cho\'s new salary after one year	The $58 payment as a percentage of Cho\'s new salary	Value of Bob\'s new salary after one year	The $58 payment as a percentage of Bob\'s new salary
$210	27.62%	$105	55.24%