# Real Interest Rates

Let’s say you lent your friend \$5 to buy 20 gum-balls for 25¢ each. You agree that he will pay you \$10 in one year’s time.

That means that in the future (with prices held constant), you'd be able to purchase 40 gum-balls with your \$10, 20 more than you would've if you purchased now!

However, what would happen if the price increased to 33¢ per gum-ball? You would not actually be 20 gum-balls better off by making the loan, but rather only 10 gum-balls better off when you account for the price increase.

This simple example represents nominal vs. real interest rates!

## Nominal interest rates (i) explained

Nominal interest rates are exactly what you would expect; they are just “normal” interest rates.

Nominal interest rates are the pure percentage gain of dollars after a certain period of time.

In our gum-ball situation, nominal interest was represented when we didn't consider inflation:

"That means that in the future (with prices held constant), you'd be able to purchase 40 gum-balls with your \$10, 20 more than you would've if you purchased now!"

However, in economics you often won't be dealing with gum-balls for calculating nominal interest rates. We'll often work with loans.

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