Real and Nominal Interest Rates

Zane Perelli currently has $100 that he can spend on shirts that cost $25 each. Alternatively, he could invest the $100 in a risk-free U.S. Treasury security, which is expected to earn a nominal interest rate of 9%. The consensus forecast of economists for the inflation rate is 5% for the next year.

a. How many shirts can Zane buy today?

b. How much money will Zane have at the end of 1 year if he doesn't make the shirt purchase today?

c. How much do you think the shirts will cost at the end of the first year in light of the expected inflation?

d. Use the calculations from parts b) and c) to determine how many shirts (including fractional shirts) Zane will be able to buy at the end of the first year. In percentage terms, how many more or fewer shirts will Zane be able to buy at the end of the first year?

What is Zane's real rate of return during the year? How does it relate to the percentage change in Zane's purchasing power calculated in part d)? Explain your answer.