ECON 272

In Class Exercise Eight – Inflation and Deflation - The CPI and The Effects of Inflation and Deflation

1.  What is the CPI and how is it measured (generally speaking)?

2.  What is the real rate of interest?  How do time preferences relate to the real rate?

3.  The nominal rate of interest = ____________________________ + _______________________________________________.

4.   If the nominal rate of interest includes an expected rate of inflation that is equal to the actual rate of inflation (after the fact) - then what will the lender earn from lending the money?  Explain.

5.  Explain how, with unanticipated inflation, debtors might gain at the expense of lenders.

6.  One effect of inflation is what is called the "investment tax" - which takes place due to the capital gains tax and inflation.

        a.  what is a capital gain -- give an example.

        b.  You buy an asset for $2000 and sell it for $4000.

                     Show work for below:

            What is your capital gain -

            In dollar terms?

            In % terms?

Assume the inflation rate is 100% during the time you held the asset.

Therefore – what can you say about your capital gain in real terms?

If the capital gains tax is 15% - do you win or lose from your investment? 

By how much?

Show work.

7.  What questions do you still have about this material?