MICROECONOMICS
MICROECONOMICS
null Edition
ISBN: 9780134519494
Author: Acemoglu
Publisher: PEARSON
Question
Chapter 15, Problem 1Q
To determine

Whether the worth of $1,000 received today and that of $1,000 received 1 year from now are equal or not.

Expert Solution & Answer
Check Mark

Explanation of Solution

According to the time value of money, a dollar in the present time is worth more than a dollar in the future. Variables like inflation (v) and interest rate (r) affect the value of money. Inflation means a rise in the price level which depreciates the currency value over time, whereas interest rate is used as a discounting factor. If the sum of $1,000 is leave-in cash as it is, then its value will depreciate because of inflation. If the same amount is deposited in a bank as saving, then the bank will pay some interest on that amount balancing it with the inflation.

Suppose, if the sum of $1,000 received now is deposited in a bank for 1 year, and the interest rate that bank is offering is around 7% . This means, r=7%=0.07. So, the interest amount after 1 year will be,

$1000+r+1,000=1+r×$1000That is,0.07+1×$1000=1,070Therefore, $1,070-$1000=$70interest amount

Hence, the sum of $1000 received today will have a value of $70 more than the sum of $1000 received 1 year after.

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