Aim for FiveMacroeconomics

Short free-response question

When inflation beats expectations

  • Units 2 and 4
  • 5 points
  • About 12 minutes

You can use a calculator on this question, just like on exam day.

A shorter question on one or two models, often with data in a table. You might calculate something like an unemployment rate, real GDP or the spending change needed to close a gap, draw a labeled graph (described in words on this site), and explain an effect. On the exam: Questions 2 and 3 of 3 in Section II; each is worth a quarter of the section score, with about 12 minutes suggested for each. A four-function calculator is allowed.

The question and its sources

A one-year loan

At the start of a year, a borrower in the country of Corrin takes out a one-year, $10,000 loan from a credit union at a fixed nominal interest rate of 7 percent. When they sign the loan, both the borrower and the credit union expect the inflation rate over the year to be 3 percent.

Over the year, Corrin's consumer price index (CPI) rises from 200 to 212.

Source: Hypothetical scenario

Suggested time: 12 minutes

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Part (a)

1 point

Calculate the actual inflation rate in Corrin over the year. Show your work.

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Part (b)

1 point

Calculate the real interest rate the credit union expected to earn when it made the loan. Show your work.

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Part (c)

1 point

Calculate the actual real interest rate on the loan. Show your work.

0 / 2,500 characters

Part (d)

1 point

Did the borrower gain or lose because inflation was higher than expected? Explain.

0 / 2,500 characters

Part (e)

1 point

Explain one reason that the CPI may overstate the increase in the cost of living for consumers in Corrin.

0 / 2,500 characters

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