5.2 Interest rates
There are prices attached to goods (like ice cream or shirts) and services (like holidays and gym memberships).
The interest rate can also be considered as a price. When taking out a loan, the interest rate is the price of borrowing money. When depositing money into a savings account, the interest rate is the benefit provided by your savings.
Have a go at the two examples in the following activity to understand how interest rates work.
How interest rates work
a.
£110
b.
£111
c.
£120
The correct answer is a.
Answer
After 1 year, Sam will have to pay:
the amount that he borrowed (the principal), which is £100, plus
the interest payment of £10. The interest payment is 10% of £100. You can calculate this by multiplying 100 with 10% (which is 10/100 = 0.10).
So, the interest payment is
£100 × 10/100 = £100 × 0.10 = £10
Therefore, the total amount that Sam will pay back is the principal of £100 plus the interest of £10, which is £110.
Alternatively, you can compute the total amount that Sam has to pay by multiplying 100 (the amount borrowed) with 1.10.
That is, the amount that Sam will pay back is
£100 × 1.10 = £110
a.
£506
b.
£530
c.
£560
The correct answer is b.
Answer
Sarah will have £530 after 1 year. This amount includes:
£500 that Sarah deposited in her savings account.
Interest payment of £30, calculated as follows:
£500 × 6/100 = £500 × 0.06 = £30
You can compute the total amount that Sarah will have by multiplying 500 (the amount deposited) with 1.06.
That is, the total amount that Sarah will have is:
£500 × 1.06 = £530
5.1 What is inflation?
