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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 Spring '10
 abijian
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