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Posted 6 months ago

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Cersei knows she will have to repay a debt of $\$ 100,000$ soon. She also anticipates there will be some inflation soon.
Under which of the following circumstances will Cersei pay back the least amount of money in real terms?
Choose 1 answer:
(A) If the actual rate of inflation is greater than the expected rate of inflation
(B) The actual rate of inflation is less than the expected rate of inflation
(c) The actual rate of inflation equals the expected rate of inflation
(D) There is no inflation at all
(E) We cannot determine this without knowing what interest rate she is paying
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Answer from Sia

Posted 6 months ago

Solution by Steps

step 1

To understand the impact of inflation on the real value of money, we need to consider the concept of real vs nominal value. The real value takes into account the purchasing power of money after adjusting for inflation

step 2

If the actual rate of inflation is greater than the expected rate of inflation, the real value of the money that Cersei has to repay will be less because the purchasing power of the currency will have decreased more than anticipated

step 3

Conversely, if the actual rate of inflation is less than the expected rate, the real value of the money repaid will be higher, as the purchasing power of the currency will not have decreased as much as expected

step 4

If the actual rate of inflation equals the expected rate of inflation, the real value of the money repaid will be as expected at the time the debt was incurred

step 5

If there is no inflation at all, the nominal value of the money repaid is equal to the real value, which means Cersei would pay back exactly $100,000 in real terms, which is not the least amount in real terms compared to a situation with higher than expected inflation

step 6

Therefore, Cersei will pay back the least amount of money in real terms when the actual rate of inflation is greater than the expected rate of inflation

Answer

A

Key Concept

Inflation and Real Value

Explanation

The real value of money decreases when actual inflation exceeds expected inflation, reducing the real amount of debt repaid.$

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