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Question from Past Microeconomics Qualifying ExamEdit

Spring 2000- Section I, Question four, George Mason University

True, False, Uncertain. Determine whether or not each of the following statements are true or false. Explain your reasoning briefly in a paragraph or two. (The explanation is often more important than the answer given). Include a carefully labeled diagram or game matrix if it helps to clarify your answer.


While mathematically possible, the observation of a negative nominal rate of interest is highly improbable.

AnswerEdit

True, The existence of a negative interest rate has the following implications:

  • 1) Future consumption is preferred to present consumption.
  • 2) Lenders will pay people to borrow funds, and
  • 3) Contingent consumption is preferred to assured consumption.

A nominal interest rate is the present price of a present good divided by the present price of a future good including adjustments for expected inflation. One can think of the nominal interest rate as representing the cost of forgone opportunities. In general, people prefer current consumption to future consumption and assured consumption versus contingent consumption. Lenders of funds also prefer receiving interest to paying interest. For all these reasons, the observation of a negative nominal rate of interest is highly improbable.


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