When the rate of inflation exceeds the rate of return on the most profitable investment available, the difference bet...

ankita96 on August 18, 2020

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Hi, can you please explain this question Thank you in advance!!

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shunhe on August 19, 2020

Hi @ankita96,

Thanks for the question! So this is basically a must be true question, where you’re completing the argument with something that must be true. So what’s happening up top? Well, we’re told that then the rate of inflation is bigger than the rate of return on the most profitable investment available, the difference between those rates is the percentage by which the value of any investment will decline at a minimum. And so if a particular investment declines by more than that percentage, then something has to be true, and that’s what we have to figure out here.

So let’s say we have the most profitable investment. It has some rate of return, say 10%. And then the rate of inflation is going to exceed that. So let’s say inflation’s at 15%. So that means that the difference between those two is 5%, so the value of that most profitable investment is going to decline by 5%.

So now let’s say we have another investment, and that’s declining by 10%.Well, that means that since inflation’s still at 15%, that investment’s rate of return is 5%. And that means it’s less profitable than the most profitable investment. So the correct answer is (C), that the investment in question is less profitable than the most profitable investment available.

Hope this helps! Feel free to ask any other questions that you might have.

ankita96 on August 19, 2020

Oh, okay that makes sense! Thank you

shunhe on August 20, 2020

You're welcome!

Bridget on June 27 at 09:54PM

I wrote a hypothetical with numbers as well. I chose the answer that inflation had risen because mathematically that would mean that the % decline is greater. How did you discern that inflation remained constant and that the number changing was the rate of return?

Emil-Kunkin on June 29 at 07:48PM

Hi, this hinges on exactly how the terms are described. The decline is defined as (inflation - max possible return). This measures a point in time. That is, it's a snapshot of the expected decline (or gain) at a given moment in time. Since both numbers are set in stone at a given point in time, we then know that if our expected return is less than the decline in question, either somehow inflation is less for us or the return is less for us. Since inflation is simply a broad measure of the economy, this makes no sense. However, since the measure of return is a measure of a hypothetical maximum it makes perfect sense for us to be under that maximum.

Emil-Kunkin on June 29 at 07:49PM

A better way to say this is that neither number changed- we simply failed to get the maximum return.

Vic04324 on October 2 at 09:53PM

I have a question. I understand how C could be true, but I'm having trouble understanding why it must be true. The stimulus states that "...the difference between those two rates will be the percentage by which, at a minimum, the value of any investment will decline." However, doesn't that conditional statement leave open the possibility that all investments decline more than that amount? I see no conditional language or connections in the stimulus that mandate that any investment has to decline by precisely the minimum amount, just that it can't decline by less than that. Further, from what I'm seeing, it never establishes that the most profitable investment declines by exactly that amount, or excludes the possibility that it (and all the others) could decline more than that.

I'll make a hypothetical to better illustrate my point. I'll use the numbers already illustrated above. Those numbers establish that the value of an investment must decline by at least 5%, but that leaves open the possibility that everything declines by 6%. In this scenario (which does not conflict with the one conditional rule provided in the stimulus), it's possible that the investment in question is indeed the most profitable investment, as every investment declined by 6%.

So why is the answer C?

Could you also explain exactly why B is incorrect as well? I see that there's the possibility of us not knowing the original profit so we can't confidently say it's less now, or the possibility that equating the terms "value" and "profit" is an error. However, the statement " the value of a particular investment declines" seems to have some inconsequential differences from "the investment in question is becoming less profitable". Given the stimulus, I don't see any reason to believe that the keyword "value" is not meant to signify "monetary value", or profitability.

Thank you in advance!

Emil-Kunkin on October 4 at 12:48AM

The passage absolutely tells us that an investment declines at the minimum amount, it's in the definition of the minimum rate.

We calculate the minimum rate of decline as follows

Min decline = I - R(most profitable investment)

The critical term is the final one. The minimum decline is defined in reference to the most profitable (real) investment, so we know that that investment actually did decline the least. This shows that the most profitable investment declines in value by the amount of I-r.

If everything does in fact decline by 6 percent, then the minimum decline is six percent. The minimum decline is determined by a real investment, not a hypothetical.

B is incorrect because we have no idea if that investment is becoming more or less profitable. It's possible that it's nominal return actually increased, but that increase was outstripped by inflation.

Vic04324 on October 5 at 04:05PM

Thank you, Emil!