1.

**Suppose you had $100 in a savings account and the interest rate was 2% per year. After 5 years, how much do you think you would have in the account if you left the money to grow?**a. More than $102

b. Exactly $102

c. Less than $102

d. Do not know

OK, so you go to the bank and deposit $100 at an interest rate of 2%. What does that mean? It means that you leave the money there and in a year you will have 2% more than you started with. Simple math version: $100 + ($100 * .2%) = $100 + $2 = $102.

But the question says that you leave the money in the bank for five years. It’s pretty easy to work through that. We’ve already done Year 1.

Year 1 $100 + ($100 * .02) = $102. This can also be expressed as $100 * 1.02 = $102.

Year 2 $102 * 1.02 = $104.04. This is where we start to see the magic of compound interest!

Year 3 $104.40 * 1.02 = $106.12 (We’ll round to the nearest penny.)

Year 4 $106.49 * 1.02 = $108.24

Year 5 $108.61 * 1.02 = $110.41

So, if you leave $100 in the bank earning 2% in annual interest, in five years you can withdraw $110.41, which is more than $102.

2.

**Imagine that the interest rate on your savings account was 1% per year and inflation was 2% per year. After 1 year, how much would you be able to buy with the money in this account?**a. More than today

b. Exactly the same as today

c. Less than today

d. Do not know

We have a good start towards answering this one. We know how to calculate how much money is in a savings account after one year. However, this time the interest rate is 1%.

$100 * 1.01 = $101

However, we are dealing with inflation here. Inflation means that prices are rising. This can happen for a variety of reasons, but usually the cost of the underlying goods is rising for one reason or another. The relevant piece of information here is that inflation is 2%. That means that $100 worth of stuff on January 1 would cost $102 to buy one year later.

Year 1 inflation $100 * 1.02 = $102

This means that even though you saved money and had it earning 1% per year, inflation has outpaced you. At the end of the year you would need $102 to buy all of that stuff, but you only have $101. Which sucks, but also means that the answer is ‘less than today.’

That's enough for today. There will be more answers tomorrow!

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