lect10PV - 106 Present Value In a number of circumstances,...

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106 Present Value In a number of circumstances, a consumer or firm must make decisions that involve costs and benefits that accrue in different years. It is important in those circumstances to compare dollar values in the same year’s dollars. Economists generally use the concept of present value. That is, all dollar values will be measured in today’s dollars. The present value of $X one year in the future is X/(1+r), where r is the interest rate. Why? Because if I invest X/(1+r) today - one year in the future I will have (1+r)*X/(1+r) = X. In general the PV of $X, t years in the future is X/(1+r) t Rule for deciding between different sequences of costs and benefits: When choosing between income "streams", choose the one with the highest PV. If r=.10, which investment would you choose if you can only pick one? 2004 2005 2006 Investment A -100 100 300 Investment B -50 75 250
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107 Suppose an individual lives for 2 years. Income in year 1 is I 1 and is I 2 in year 2. The PV of this person's income stream is I
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lect10PV - 106 Present Value In a number of circumstances,...

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