If you're seeing this message, it means we're having trouble loading external resources on our website.

If you're behind a web filter, please make sure that the domains ***.kastatic.org** and ***.kasandbox.org** are unblocked.

Main content

Current time:0:00Total duration:3:10

AP.MACRO:

MEA‑3 (EU)

, MEA‑3.B (LO)

, MEA‑3.B.1 (EK)

, MEA‑3.B.2 (EK)

let's say last year I put $100 into some types some type of savings account in a bank so this is a year ago and that now today exactly one year later that hundred and ten dollar dollars has grown to one hundred and ten dollars so this is now so if you look at if you look at things just in the absolute dollar terms things have grown by ten dollars so I made $10 off of an original hundred dollar investment off of a hundred dollar investment so I got a 10% return but what I want to think about is does this really capture how much more I can buy with this hundred and ten dollars then I could buy with that hundred dollars before can i really buy ten percent more goods and services today than i could a year ago and to think about that let's think about what a hypothetical inflation rate from last year to this year so let's say that the inflation let's say that the inflation ended up being two percent between a year ago and today if that's the case what is a hundred dollars a hundred dollars a year ago in today's money in today's money well if inflation was two percent then a hundred dollars a year ago would buy you the same stuff that 102 dollars would buy you today so it would be a hundred and two dollars so what is the dollar return in today's money dollar return in today's money in the current in today's money the current purchasing power well we're getting 110 dollars we get 110 dollars and we invested in today's money 102 dollars if we look at it from today's terms we invested something that gives me it's the same purchasing power as 102 dollars a day and now it's giving us a purchasing power of 110 dollars so we've gotten eight dollars more of purchasing power in today's money so what was that what is the actual real return so let me write it in real return and we can do it in today's money and you can do it either way you could discount the 110 - a year ago money and figure out the real return there and figuring out the the prot the actual dollar return and do the calculation or you can all do it you can do it today in today's money and maybe I'll do it the previous way in the next video but the real return is we got up we got we made eight dollars over the course of the year in today's money and what we originally invested in today's money was a hundred and two dollars one hundred and two dollars and so we get our calculator out eight divided by 102 is seven point eight percent so this is equal to seven point eight percent so even though the nominal return the fit the number if we just look at the if we just look at what we got in exchange for what we invested even though the the nominal return was ten percent because there was two percent inflation our actual purchasing power only increased by seven point eight percent

AP® is a registered trademark of the College Board, which has not reviewed this resource.