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Forty years ago, a gallon of gas cost $ 1 . 2 0 . Today, a gallon of gas costs 2 . 6 0 .

Forty years ago, a gallon of gas cost $1.20. Today, a gallon of gas costs 2.60.
Suppose that the gas price increase has been entirely due to inflation.
a. Calculate the annual inflation rate.
b. Today, you plan to make a cash purchase for a new car. The Model K costs $24,000
and you estimate the car will last 10 years and require 600 gallons per year. The
Model M costs $28,000 but gets better mileage, so it will only require 400 gallons per
year. The cars are identical in all other respects, and they will both be worthless after
10 years.
Assume that gas prices will rise by the rate of inflation (that you calculated in part a.
Further assume that all gas expenditures are incurred at the end of the year. If the
nominal interest rate is 9% per year, which car should you purchase? Show all
calculations and explain carefully.

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