# Interest, Inflation, and Purchasing Power: A Guide to Financial Understanding

## How does inflation affect Devon's deposit and purchasing power?

Suppose Devon is a fan of young-adult fiction and buys only young-adult books. Devon deposits $2,000 into a savings account that pays an annual nominal interest rate of 20%. On the day she makes her deposit, a young-adult book has a price of $20.00. How does inflation impact the purchasing power of Devon's deposit over time?

## Understanding the Impact of Inflation on Devon's Deposit

When the inflation rate is 5%, the real interest rate is 15%. To determine the purchasing power of Devon's deposit after one year, we need to consider the impact of inflation on the price of young-adult books.

Let's calculate the new price of a young-adult book based on the given inflation rates and then determine the purchasing power of Devon's deposit.

Given: - Initial deposit: $2,000 - Annual nominal interest rate: 20% - Initial price of a young-adult book: $20.00

First, let's calculate the new price of a young-adult book after one year, assuming it rises at the rate of inflation:

- Inflation rate: 5% New price of a young-adult book: $20.00 + ($20.00 * 5%) = $21.00

Now, let's determine the purchasing power of Devon's deposit after one year:

Purchasing power = Deposit amount / Price of a young-adult book

Purchasing power = $2,000 / $21.00 = 95.24 young-adult books

Since we are asked to round down to the nearest whole number of young-adult books, the purchasing power after one year would be 95 young-adult books.

Next, let's calculate the real interest rate at each of the given inflation rates:

Real interest rate = Nominal interest rate - Inflation rate

- Inflation rate: 5% Real interest rate = 20% - 5% = 15%