#24 - When the rate of inflation exceeds the rate of return

[Administrator]

Complete Question Explanation

Must be True-FIB. The correct answer choice is (C)

While this is kind of an odd question stem, it really is just a basic Must Be True question. You are still being asked to determine the answer choice that would follow from the information provided in the stimulus. The first sentence of the stimulus is introducing the concept of the minimum decline in value of an investment when the most profitable investment available is growing at a rate lower than inflation. The second sentence begins by discussing a separate investment which is declining by a greater percentage than the percentage between inflation and the most profitable investment.

Answer Choice (A): This answer is incorrect because the percentage between the most profitable investment available and inflation would have already changed to compensate for this increase.

Answer Choice (B): The percentage being referenced was not created to determine the difference between the current profitability of an investment and how that investment has done previously. It is used to determine the profitability of an investment in relation to the most profitable investment available.

Answer Choice (C): This is the correct answer choice. If there is a bigger percentage gap between inflation and this particular investment than there is between inflation and the most profitable investment available, then it must follow that this particular investment is less profitable.

Answer Choice (D): Just like Answer Choice (A), this answer is incorrect because the percentage between the most profitable investment available and inflation would have already changed to compensate for this decrease.

Answer Choice (E): Once again, this answer is incorrect because the percentage between the most profitable investment available and inflation would have already changed to compensate for this change in which investment happened to be the most profitable.

[poslaw]

On page 9-99 of lesson 9, question 19 is giving me a bit of trouble. Can someone please run through the explanation for me. Thanks!!!

[Steve Stein]

Part of what makes this one a bit confusing is the financial terminology, and the abstract scenario.

Lets say the best investment available has a current value of $100. If its annual rate of return is 10%, but the annual inflation rate is 11%, then the value of that investment will drop by 1% over the year. (And that's the best investment available!)

Let's say that over that same time, we've seen a second investment drop in value by 2%. It must be that this second investment is less profitable than the first investment. That answer is provided by choice C.

[poslaw]

Thank you. Just one more question. I chose answer choice B. Can you point out the issue with that. Is it an incomplete answer since it doesnt touch upon "most profitable investment available" as C does?

[Steve Stein]

That's a tricky answer choice as well--its a bit like the difference between speed and accelaration. Back to that same hypothetical, if the investment in question is losing value at a rate of 2% annually, that doesn't mean that it is becoming less profitable--rather, you'd be losing money at a steady 2% annual rate.

In a different hypothetical, let's say you have an investment that pays you 10% interest year after year (and no inflation): you'll see the value of the initial investment increase, even though the rate of profit will remain a constant 10% over the years. In other words, even though the value increases over time, it would not be correct to say that the investment is becoming increasingly profitable. Rather, it remains consistently profitable.

Does that make sense? let me know--thanks!

[alee]

Hi guys!

This is a question about Q24, Feb 1994, Section IV. I understood the stimulus as the following:
-The *minimum*percentage by which the value of *any* investment will decline = rate of inflation - rate of return on *the most profitable* investment
-If *in such a circumstance* the value of *a particular* investment declines by more than that percentage, it must be true that...

The correct answer is C: 'the investment in question is less profitable than the most profitable investment available'.

I can see why this *could* be true, but why is it case that it *must*? It seems that by the definition of the decline in value of the investment, it could have also been the case that the rate of inflation went up (option A) or the rate of return on the most profitable investment went down (option D).

The only way I can see of excluding A and D is by interpreting 'in such a circumstance' to mean 'holding the rate of inflation and rate of return on the most profitable investment *as fixed*. However, that doesn't seem to be doable within the scope of the question.

Could you please suggest a clearer/more correct rationale for arriving at the solution?

Thanks guys!

[Adam Tyson]

Hi Alee! I'll admit I don't have that question in front of me, but I have seen it before, so I hope I can answer it based on just your information and my memory.

When a particular investment is the most profitable one, then it's rate of return, plugged in to the formula they gave us, will always give us the minimum percentage. That is, it's the ruler by which all others are measured. If an investment falls by more than that, it's by definition not the most profitable, and must be less than the most profitable.

Try throwing some numbers at the formula - make up a rate of inflation, a rate of return for the most profitable investment, and subtract one from the other to get the minimum percentage. Then throw into the mix an investment that declines by more than that difference. What happens? Keep in mind that the stimulus gives us a snapshot in time - it doesn't ask us to compare an investment now to the same investment later. That's where those wrong answers take you - into a change over time in one of the numbers. Freeze time, and just compare this particular investment to the one that is simultaneously the most profitable.

Hope that helps!

Adam M. Tyson
PowerScore LSAT Instructor

[ifstudythenkill]

LR Question Type Training pg 39 Q 58 is making me lose sleep.

[Jon Denning]

Thanks for the question, and I like the username (clearly someone's got conditional reasoning on the brain)

First off, I’ve seen this one (#24) from the second LR section of the February 1994 LSAT give lots of other people fits as well. Very tricky, and feels almost like you need an economics degree to decode what’s happening, but hopefully I can help walk you through it.

Let’s break down what this stimulus is actually saying first, then we’ll look at the answers. To start, we’re given basically a description of our best case scenario when inflation (think losses) is higher than returns (gains): we’re definitely going to lose money, and the minimum percent we’ll lose (our best case) is determined by whatever is our best/most profitable investment, since that one will have the highest return, albeit still not as high as inflation. That’s the baseline for what we’ll lose, and if we have other investments that are less profitable, well then they’re going to lose even more, percentage-wise!

Consider some numbers to possibly make that idea clearer:

Inflation: 10%
Best Investment Return: 5%
Second Best Investment Return: 2%

In basic econ terms, we’re gaining or losing the difference between inflation and return for each investment. In this hypothetical, as in the stimulus, inflation is higher so we’re losing. What’s the minimum loss? That’s inflation minus best return, so 10% - 5% = 5% loss. And since all of our other investments return less, they’ll all lose even more. So our second best investment suffers a 10% - 2% = 8% loss. Other, worse investments? Other, greater losses.

So that’s the first sentence essentially: our best investment tells us our minimum loss, and worse investments will have greater losses. What happens next is we’re told that on one particular investment, we do in fact lose even more than our minimum amount. What does that tell us about that investment? Well it must be less profitable than our best case, highest return investment. Like our 8% loss in the example above: if we’re losing more than the minimum, we must be dealing with an investment that’s not our best.

And so we reach the end of the stimulus and are asked to fill in the blank with what must be true. Hopefully at this point you can see where this is going: answer choice (C) is exactly what I just described, where the investment in question isn’t our most profitable investment (“less profitable than the most profitable,” to quote it).

For the other answers, we either cannot know that they’re true (could be, but not must be): (A) we know inflation is higher than returns, but inflation doesn’t have to be increasing; it could stay the same, or even drop, so long as returns are still lower than it; (B) same idea as (A) where we don’t know that returns are dropping for the investment, we only know that they’re lower than inflation, and lower than our most profitable, minimum loss investment-----or they don’t fit the specifics of “such a circumstance”: (D) we’re being asked about an investment that is NOT our most profitable, so conclusions about what is occurring with our most profitable are unknowable and unrelated; (E) again, we don’t know anything about our most profitable investment here, aside from the fact that we’re not being asked about it.

Tough question, and no surprise that it was late in the section (again, question 24 from February 1994), but hopefully that helps you make some sense of it.

Let me know if that clears it up, or if you still have questions!

Jon

[ifstudythenkill]

Thank you, Jon, for your quick and generous reply!
Thanks for liking my username, and please note: the S and N are by design and NOT a Mistaken Reversal!

Now I see that my problem arose because I did not believe that “Value” is synonymous with “Rate of Return.”

I was tracking your reasoning about which investment will have greatest “loss.” I had summarized the equation the same way: Rate of inflation – Rate of Return of most profitable investment = minimum percent-change in value decline of any investment (which I abbreviated “P” as opposed to your term “loss”).

However, after that step, I added another equation:

Decline in Value (DV) is greater than or equal to P (or “loss”)

I did this because I believed that there are other factors that can decrease “value” of an investment” eg, market conditions that might be present when said inflation rate/return rates are changing. Value of an investment is typically something that is appraised and is dependent on myriad factors, not simply rate of return.

Using my equation DV greater than or equal to P, there is no way to answer the question stem because it is possible that the most profitable investment could decrease in value more than any other investment (owing to other market factors that could corelate with inflation rate, return rate, etc. All I could do at that point was rule out (A) and (D) as garbage answers.

Is this an example of LSAC expecting you to bring a certain level of background knowledge to the test? Even so, I think the way in which they used the term “value” was simply wrong and wouldn't fly with an economist or even a layman. There are many types of investments (not just interest-bearing cash investments) that generate profit in many different ways (resale, speculation, etc) and therefore have “Value” defined in ways different from the question's formula.

Perhaps they should have phrased the question as follows:
“When the rate of inflation exceeds the rate of return on the most profitable CASH investment...”

Am I completely out to lunch here?