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Principles of Economics- Mankiw (5th) 549

Principles of Economics- Mankiw (5th) 549 - CHAPTER 25...

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Unformatted text preview: CHAPTER 25 SAVING, INVESTMENT, AND THE FINANCIAL SYSTEM 567 Imagine that someone offered to give you $100 today or $100 in ten years. Which would you choose? This is an easy question. Getting $100 today is clearly better, because you can always deposit the money in a bank, still have it in ten years, and earn interest along the way. The lesson: Money today is more valuable than the same amount of money in the future. Now consider a harder question: Imagine that someone offered you $100 today or $200 in ten years. Which would you choose? To answer this question, you need some way to compare sums of money from different points in time. Economists do this with a concept called present value. The present value of any future sum of money is the amount today that would be needed, at current interest rates, to produce that fu- ture sum. To learn how to use the concept of present value, let’s work through a couple of simple problems: Question: If you put $100 in a bank account today, how much will it be worth in N years? That is, what will be the future value of this $100? Answer: Let’s use r to denote the interest rate ex- pressed in decimal form (so an interest rate of 5 percent means r 0.05). If interest is paid each year, and if the in- terest paid remains in the bank account to earn more in-...
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