You bought some shares of stock and, over the next year, the price per share increased by 5 percent, as did the price level. Before taxes, you experienced

Question

a. both a nominal gain and a real gain, and you paid taxes on the nominal gain.
b. a nominal gain, but no real gain, and you paid taxes on the nominal gain.
c. a nominal gain, but no real gain, and you paid no taxes on the transaction.
d. both a nominal gain and a real gain, and you paid taxes only on the real gain.

Answer 1

In this scenario, you bought shares of stock, and over the next year, both the stock price and the price level increased by 5 percent.

1. Nominal Gain: This is the increase in the stock price before adjusting for inflation. Since the price of the stock increased by 5%, you have a nominal gain of 5%.

2. Real Gain: This considers the inflation effect. Since the overall price level also increased by 5%, your purchasing power didn't actually increase. Therefore, there is no real gain. The nominal gain was exactly offset by the inflation.

3. Tax Implications: Typically, taxes are assessed on the nominal gains, not real gains. Since you have a nominal gain, you would be taxed accordingly.

Given this analysis, the correct answer is:

b. a nominal gain, but no real gain, and you paid taxes on the nominal gain.