Changes

Money, like anything else, has an opportunity cost.  Just as it is a waste of your time to sit and watch television for a few hours, it is a waste of money to have it sit idle without earning anything for several years.  At a minimum, it could be earning interest.

Money, like anything else, has an opportunity cost.  Just as it is a waste of your time to sit and watch television for a few hours, it is a waste of money to have it sit idle without earning anything for several years.  At a minimum, it could be earning interest.

This was explained by Jesus in his Parable of the Talents, in Matthew 25:14-30 (RSV):  

This was explained by Jesus in His Parable of the Talents, in Matthew 25:14-30 (RSV):  

:For it will be as when a man going on a journey called his servants and entrusted to them his property; to one he gave five talents, to another two, to another one, to each according to his ability. Then he went away.  

:For it will be as when a man going on a journey called his servants and entrusted to them his property; to one he gave five talents, to another two, to another one, to each according to his ability. Then he went away.  

:For to every one who has will more be given, and he will have abundance; but from him who has not, even what he has will be taken away. And cast the worthless servant into the outer darkness; there men will weep and gnash their teeth.

:For to every one who has will more be given, and he will have abundance; but from him who has not, even what he has will be taken away. And cast the worthless servant into the outer darkness; there men will weep and gnash their teeth.

Jesus was concerned with something far greater than money.  But the point applied to money also:  money does have a time value to it.  Money tomorrow is not worth as much as the same amount of money today.

Jesus was concerned with something far greater than money.  But the point applies to money also:  money does have a time value to it.  Money tomorrow is not worth as much as the same amount of money today.

How can you compare future money to present money?  By calculating the “present value of money.”  That is how much one would need in the present which, with investment, would equal the proposed future payment.  We use the interest rate to determine how something today should be worth in the future, or how much a payment promised in the future is worth today.

How can you compare future money to present money?  By calculating the “present value of money.”  That is how much one would need in the present which, with investment, would equal the proposed future payment.  We use the interest rate to determine how much something today should be worth in the future, or how much a payment promised in the future is worth today.

If I promise to give you $100 in 5 years, and the interest rate is 5% annually, then ask yourself how much you would need today to generate that same $100 in 5 years.  It would be less than $100, because you could earn interest on it.  In fact, you would only need $100 divided by (1.05) times itself 5 times (i.e, 1.05 x. 1.05 x 1.05 x. 1.05 x. 1.05)

If I promise to give you $100 in 5 years, and the interest rate is 5% annually, then ask yourself how much you would need today to generate that same $100 in 5 years.  It would be less than $100, because you could earn interest on it.  In fact, you would only need $100 divided by (1.05) times itself 5 times (i.e, 1.05 x. 1.05 x 1.05 x. 1.05 x. 1.05)

Using a calculator, that comes to $78.35.  That’s amazing, isn’t it?  Receiving $100 in 5 years is equivalent to only $78.35 today, assuming an interest rate of 5 %.

Using a calculator, that comes to $78.35.  That’s amazing, isn’t it?  Receiving $100 in 5 years is equivalent to only $78.35 today, assuming an interest rate of 5%.

We can check our work.  If you had $78.35 today and you invested it the bank at an interest rate of 5%, then next year it would be worth 5% more: $78.35 x 1.05 = $82.27

We can check our work.  If you had $78.35 today and you invested it the bank at an interest rate of 5%, then next year it would be worth 5% more: $78.35 x 1.05 = $82.27

==Investment Decisions==

==Investment Decisions==

Using the time value of money, now we can make investment decisions.  As an owner of a company or just someone wanting to see your savings grow, you will need to make investment decisions.

Using the time value of money, now we can make investment decisions.  As an owner of a company or merely someone wanting to see your savings grow, you will need to make investment decisions.

Suppose your widget company is considering a new machine that will last for two years and costs $3500.  Suppose also that it will be worthless afterward.  Suppose further that it will bring in revenue of $2000 per year, and that interest rates are 10%.  Should you invest in the machine?

Suppose your widget company is considering a new machine that will last for two years and costs $3500.  Suppose also that it will be worthless afterward.  Suppose further that it will bring in revenue of $2000 per year, and that interest rates are 10%.  Should you invest in the machine?

:($2000/1.10) + ($2000/(1.10x1.10)) = $1818.18 + $1652.89 = 3471.07

:($2000/1.10) + ($2000/(1.10x1.10)) = $1818.18 + $1652.89 = 3471.07

Look again at its cost.  What is your decision?  Don’t buy it.

Look again at its cost.  What is your best decision?  Don’t buy it.

==Economic Rent==

==Economic Rent==

(4) Economic rent is the payment of a factor of production in excess of the factor’s opportunity cost or supply cost.

(4) Economic rent is the payment of a factor of production in excess of the factor’s opportunity cost or supply cost.

This is one of the most complex concepts of the course.  But this should help: '''''economic rent is the amount that a monopoly can charge in excess of the good’s cost'''''.  Economic rent is the surplus enjoyed by the recipient, at the expense of the person paying it.   

This is one of the most complex concepts of the course.  But this should help: '''''economic rent is the amount that a monopoly can charge in excess of the good’s cost'''''.  Economic rent is the surplus enjoyed by the seller, at the expense of the person paying it.   

Suppose there is only one house on a peninsula overlooking the ocean out of both sides of the house.  The economic rent is the excess in price that the owner can charge due its unique location.  The supply is one, and anyone determined to have that house must pay whatever price is charged.  Of course, the Law of Demand places a limit on the rent, because people can’t pay what they don’t have, nor will they pay more than what they value something at.  But the overcharge due to the uniqueness of the good is what constitutes the “economic rent.”

Suppose there is only one house on a peninsula overlooking the ocean out of both sides of the house.  The economic rent is the excess in price that the owner can charge due its unique location.  The supply is one, and anyone determined to have that house must pay whatever price is charged.  Of course, the Law of Demand places a limit on the rent, because people can’t pay what they don’t have, nor will they pay more than what they value something at.  But the overcharge due to the uniqueness of the good is what constitutes the “economic rent.”

==Economic Profits==

==Economic Profits==

Remember that “economic profits” include far more than ordinary “accounting profits” or “profits” in the ordinary sense of the term.  “Economic profits” are total revenues minus costs that include opportunity costs, time value of money, and other hidden costs missing from most claims about profits.  Economic profits are much harder to come by.

Remember that “economic profits” include far more than ordinary “accounting profits” or “profits” in the ordinary sense of the term.  “Economic profits” are total revenues minus costs that include opportunity costs, time value of money, and other hidden costs missing from most statements about profits.  Economic profits are much harder to come by.

Who enjoys true economic profits?  Monopolies do, because they can increase their price and reap economic rents.  Microsoft garners hefty profits year after year, with no end in sight.  But ultimately all monopolies, even Microsoft, fall prey to competition and those economic profits dry up.  However, that process can be painfully slow for consumers seeking to realize those competitive benefits now.

Who enjoys true economic profits?  Monopolies do, because they can increase their price and reap economic rents.  Microsoft garners hefty profits year after year, with no end in sight.  But ultimately all monopolies, even Microsoft, fall prey to competition and those economic profits dry up.

Inventors and other innovators can enjoy real economic profits.  Thomas Edison did, with his numerous marvelous patented inventions.  Patents give the holder an exclusive right to the product for 17 years.  Competition is prevented for that time, and enormous economic profits can be obtained without competition driving the price down.  AT&T used Alexander Graham Bell’s patent on the telephone to build a highly profitable company for a century.  But ultimately its economic profits dried up, too.

Inventors and other innovators can enjoy real economic profits.  Thomas Edison did, with his numerous marvelous patented inventions.  Patents give the holder an exclusive right to the product for 17 years.  Competition is prevented for that time, and enormous economic profits can be obtained without competition driving the price down.  AT&T used Alexander Graham Bell’s patent on the telephone to build a highly profitable company for a century.  But ultimately its economic profits dried up, too.

==Assignment==

==Assignment==

Read this lecture and look at some of the problems on the midterm exam.  The homework assignment is light this week to give you time to spend reviewing concepts in the course.  Then answer the problems below:

Read this lecture and look at some of the problems on the midterm exam.  The homework assignment is light this week to give you time to spend reviewing concepts in this course.  Then answer the problems below:

Answer 5 out of 6:

Answer 5 out of 6:

1.  If you were to loan someone money, why would you want him to pay you something extra (interest) when he pays back the loan?  Give at least one reason.

1.  If you were to loan someone money, why would you want him to pay you something extra (interest) when he pays back the loan?  Give at least one reason.

2.  Suppose I loaned you $1000 today, and interest rates are 5% per year (compounded annually), and you repaid the loan plus interest in 2 years, then what is the total you would pay to satisfy the debt?

2.  Suppose I loaned you $1000 today, and interest rates are 5% per year (compounded annually), and you repaid the loan plus interest in 2 years, then what is the total you would pay to satisfy this debt?

3.  Review:  is the cost of the bus for a trip to D.C. a "fixed cost" or a "variable cost"?  Explain.

3.  Review:  is the cost of the bus for a trip to D.C. a "fixed cost" or a "variable cost"?  Explain, assuming for the purpose of this question that one and only one bus can be used (in reality, we may have several buses).

4.  Which concept in Economics is the best as a self-motivator, which you might use to do and achieve more?

4.  Which concept in Economics do you think is the best self-motivator, which you might use to achieve more?

5.  Suppose I will pay you $1000 in two years, and the interest rate is 10% per year, compounded annually.  How much should you pay me today to receive $1000 in two years?  Show your work.

5.  Suppose I will pay you $1000 in two years, and the interest rate is 10% per year, compounded annually.  How much should you pay me today to receive $1000 in two years?  Show your work.

6.  Pick another question from the midterm exam that you answered incorrectly, and explain how you understand why a different answer is correct.

6.  Pick another question from the midterm exam that you answered incorrectly, and explain the correct answer.

===Honors===

===Honors===

9.  What is your favorite concept in Economics, and why?

9.  What is your favorite concept in Economics, and why?

10.  Nash equilibrium, revisited:  What is the Nash equilibrium for two gas stations (an oligopoly) that are situation immediately across the street from each other?  In other words, what price to they sell at, expressed in terms of one of their cost measures?  Explain the process that reaches that "equilibrium".

10.  Nash equilibrium, revisited:  What is the Nash equilibrium for two gas stations (an oligopoly) that are situation immediately across the street from each other?  In other words, what price do they sell at, expressed in terms of one of their cost measures?  Explain the process that reaches that "equilibrium".

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[[Category:Economics lectures]]

[[Category:Economics lectures]]

{{DEFAULTSORT: Economics Lecture 12}}

{{DEFAULTSORT: Economics Lecture 12}}