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Lecture Issues in economics today - Chapter 4

When you finish this chapter, you should: Define the key terms of economics and opportunity cost and understand how a production possibilities frontier exemplifies the trade-offs that exist in life, distinguish between increasing and constant opportunity cost and understand why each might happen in the real world, analyze an argument by thinking economically, while recognizing and avoiding logical traps. | Lecture Issues in economics today - Chapter 4 Chapter 4 Interest Rates and Present Value McGraw Hill Irwin 2002 The McGraw Hill Companies Inc. All Rights Reserved. Chapter Outline Interest Rates Present Value McGraw Hill Irwin 2002 The McGraw Hill Companies Inc. All Rights Reserved. Interest Rates The Market for Money McGraw Hill Irwin 2002 The McGraw Hill Companies Inc. All Rights Reserved. Interest Rate The interest rate is the percentage usually expressed in annual terms of a balance that is paid by a borrower to a lender that is in addition to the original amount borrowed or lent. McGraw Hill Irwin 2002 The McGraw Hill Companies Inc. All Rights Reserved. Figure 1 The Market for Money Interest Supply rate r r Demand Money Borrowed Saved McGraw Hill Irwin 2002 The McGraw Hill Companies Inc. All Rights Reserved. Nominal vs. Real Interest Rates Nominal Interest Rate the advertised rate of interest Real Interest Rate the rate of interest after inflation expectations are accounted for the compensation for waiting on consumption McGraw Hill Irwin 2002 The McGraw Hill Companies Inc. All Rights Reserved. Present Value Present Value is the interest adjusted value of future payment streams. Mathematically the present value of a payment is payment 1 r n Where r is the interest rate n is the number of years until the payment is received made. McGraw Hill Irwin 2002 The McGraw Hill Companies Inc. All Rights Reserved. The Amount Payable for Every Dollar Borrowed For several interest rates and loan durations Interest 20 10 5 2 1 rate - gt Years 30 237.38 17.45 4.32 1.81 1.35 10 6.19 2.59 1.63 1.22 1.10 5 2.49 1.61 1.28 1.10 1.05 1 1.20 1.10 1.05 1.02 1.01 McGraw Hill Irwin 2002 The McGraw Hill Companies Inc. All Rights Reserved. Examples From This Table If you borrow 1 and promise to pay it back in 5 years at 5 interest you will owe 1.28 which is the original 1 plus 28 cents in interest. If you borrow 1 and promise to pay it back in 30 years at 20 interest you will owe .