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| | {{Economics_Lectures}} | | {{Economics_Lectures}} |
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| − | The midterm exam is part of this course, and please refer to the questions you answered incorrectly -- and perhaps a few that you answered correctly -- to ensure you fully understand the concepts. Be prepared to apply those same principles correctly to new problems.
| + | This week's lecture is shorter an the homework assignment is easier than usual, in honor of the Thanksgiving break. There will be no class next week. |
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| | + | We are now two weeks past the midterm, but do not forget that the midterm exam is part of this course, and please refer to the questions you answered incorrectly -- and perhaps a few that you answered correctly by guessing. Make sure that you fully understand as many of the concepts as possible. Be prepared to apply those same principles correctly to new problems. The lighter lecture and assignment this week give you the opportunity to "catch up" on aspects of this course you haven't yet fully learned. |
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| | We have learned 80% of the course material and you can begin applying your knowledge to businesses and activities that you encounter in your daily lives. For example, what are the costly inputs and sources of revenue for a newspaper? A movie theater? A book? How elastic are the demands in those markets? How competitive or monopolistic? The more you quiz yourself, the better you will learn the principles. | | We have learned 80% of the course material and you can begin applying your knowledge to businesses and activities that you encounter in your daily lives. For example, what are the costly inputs and sources of revenue for a newspaper? A movie theater? A book? How elastic are the demands in those markets? How competitive or monopolistic? The more you quiz yourself, the better you will learn the principles. |
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| | ==Interest== | | ==Interest== |
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| − | “There’s no free lunch,” according to the famous saying. “It costs money to make money” is another aphorism. Most bank's ATMs charge $1.50 just to withdraw cash from your account at a different bank. | + | “There’s no free lunch,” according to the famous saying. “It costs money to make money” is another aphorism. Most bank's ATMs charge $2 or $3 just to withdraw cash from your account at a different bank. |
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| | If you asked me to loan you $1000, then I might answer: why? What’s in it for me? You would then say that you promise to give it back. I would then say why should I give it to you in the first place? If I just keep the money, then I won’t have to worry about your giving it back. | | If you asked me to loan you $1000, then I might answer: why? What’s in it for me? You would then say that you promise to give it back. I would then say why should I give it to you in the first place? If I just keep the money, then I won’t have to worry about your giving it back. |
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| | The concept of "compounded interest" refers to earning interest on the interest. "Compounded yearly" or "compounded annually" means that the interest is added to the total amount due at the end of the year, and then the interest for the next year is calculated by including the interest for the first year: | | The concept of "compounded interest" refers to earning interest on the interest. "Compounded yearly" or "compounded annually" means that the interest is added to the total amount due at the end of the year, and then the interest for the next year is calculated by including the interest for the first year: |
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| − | :$1000 is loaned to you today at an interest rate of 5%, compounded annually. | + | :*$1000 is loaned to you today at an interest rate of 5%, compounded annually. |
| − | :After one year, the amount due is $1000 plus 5% of $1000, for a total of $1050. | + | :*After one year, the amount due is $1000 plus 5% of $1000, for a total of $1050. |
| − | :After two years, the amount due is %1050 plus 5% of %1050, for a total of $1102.50, because the interest on the first year is compounded in calculating the interest for the second year. | + | :*After two years, the amount due is $1050 plus 5% of $1050, for a total of $1102.50, because the interest on the first year is compounded in calculating the interest for the second year. |
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| | The opposite of "compounded" interest is "simple" interest. In that case, the total about due the second is $1000 plus 5% of $1000 plus another 5% of $1000, for a total of $1100. Notice how the total amount under compounded interest is always larger than the total amount using simple interest. | | The opposite of "compounded" interest is "simple" interest. In that case, the total about due the second is $1000 plus 5% of $1000 plus another 5% of $1000, for a total of $1100. Notice how the total amount under compounded interest is always larger than the total amount using simple interest. |
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| | 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. |
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| − | From 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. He who had received the five talents went at once and traded with them; and he made five talents more. So also, he who had the two talents made two talents more. But he who had received the one talent went and dug in the ground and hid his master's money. Now after a long time the master of those servants came and settled accounts with them. And he who had received the five talents came forward, bringing five talents more, saying, 'Master, you delivered to me five talents; here I have made five talents more.' His master said to him, 'Well done, good and faithful servant; you have been faithful over a little, I will set you over much; enter into the joy of your master.' And he also who had the two talents came forward, saying, 'Master, you delivered to me two talents; here I have made two talents more.' His master said to him, 'Well done, good and faithful servant; you have been faithful over a little, I will set you over much; enter into the joy of your master.' He also who had received the one talent came forward, saying, 'Master, I knew you to be a hard man, reaping where you did not sow, and gathering where you did not winnow; so I was afraid, and I went and hid your talent in the ground. Here you have what is yours.' But his master answered him, 'You wicked and slothful servant! You knew that I reap where I have not sowed, and gather where I have not winnowed? Then you ought to have invested my money with the bankers, and at my coming I should have received what was my own with interest. So take the talent from him, and give it to him who has the ten talents. 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.”
| + | This was explained by Jesus in his Parable of the Talents, in Matthew 25:14-30 (RSV): |
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| − | Jesus was concerned with something far greater than money in this parable. But money does have a time value to it. Money tomorrow is not worth as much as the same amount of money today. | + | :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. |
| | + | :He who had received the five talents went at once and traded with them; and he made five talents more. So also, he who had the two talents made two talents more. But he who had received the one talent went and dug in the ground and hid his master's money. |
| | + | :Now after a long time the master of those servants came and settled accounts with them. And he who had received the five talents came forward, bringing five talents more, saying, 'Master, you delivered to me five talents; here I have made five talents more.' His master said to him, 'Well done, good and faithful servant; you have been faithful over a little, I will set you over much; enter into the joy of your master.' And he also who had the two talents came forward, saying, 'Master, you delivered to me two talents; here I have made two talents more.' His master said to him, 'Well done, good and faithful servant; you have been faithful over a little, I will set you over much; enter into the joy of your master.' He also who had received the one talent came forward, saying, 'Master, I knew you to be a hard man, reaping where you did not sow, and gathering where you did not winnow; so I was afraid, and I went and hid your talent in the ground. Here you have what is yours.' But his master answered him, 'You wicked and slothful servant! You knew that I reap where I have not sowed, and gather where I have not winnowed? Then you ought to have invested my money with the bankers, and at my coming I should have received what was my own with interest. So take the talent from him, and give it to him who has the ten talents. |
| | + | :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.” |
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| | + | 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. |
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| | 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 something today should be worth in the future, or how much a payment promised in the future is worth today. |
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| − | If I promise to give you $100 in 5 years, and the interest rate is 5%, 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) |
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| − | 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 %. |
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| | 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 |
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| − | You would do the same thing in the second year, investing it for a return of 5%: | + | You would do the same thing in the second year, investing it for a return of 5%: $82.27 x 1.05 = $86.38 |
| − | $82.27 x 1.05 = $86.38 | |
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| − | And again in year three: | + | And again in year three: $86.38 x 1.05 = $90.70 |
| − | $86.38 x 1.05 = $90.70 | |
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| − | And again in year four: | + | And again in year four: $90.70 x 1.05 = $95.24 |
| − | $90.70 x 1.05 = $95.24 | |
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| − | And, finally, one more time for the fifth year: | + | And, finally, one more time for the fifth year: $95.24 x 1.05 = $100 |
| − | $95.24 x 1.05 = $100 | |
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| | So $100 to be paid five years from now is the same thing as receiving only $78.35 today. That’s due to the effect of the time value of money. | | So $100 to be paid five years from now is the same thing as receiving only $78.35 today. That’s due to the effect of the time value of money. |
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| | 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 just someone wanting to see your savings grow, you will need to make investment decisions. |
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| − | 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 afterwards. 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? |
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| | Ask yourself what the time value of the added income is. It equals: | | Ask yourself what the time value of the added income is. It equals: |
| − | ($2000/1.10) + ($2000/(1.10x1.10)) = $1818.18 + $1652.89 = 3471.07
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| − | Look again at its cost. Your decision? Don’t buy it. | + | :($2000/1.10) + ($2000/(1.10x1.10)) = $1818.18 + $1652.89 = 3471.07 |
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| | + | Look again at its cost. What is your decision? Don’t buy it. |
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| | ==Economic Rent== | | ==Economic Rent== |
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| | (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. |
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| − | 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 recipient, at the expense of the person paying it. |
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| | 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.” |
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| | 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 the course. Then answer the problems below: |
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| − | Answer 4 out of 5: | + | Answer 5 out of 6: |
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| | 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. |
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| | 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. |
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| | + | 6. Pick another question from the midterm exam that you answered incorrectly, and explain how you understand why a different answer is correct. |
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| | ===Honors=== | | ===Honors=== |
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| | 10. What is your favorite concept in Economics, and why? | | 10. What is your favorite concept in Economics, and why? |
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| − | 11. Nash equilibrium, revisited: What is the Nash equilibrium for two gas stations (an oligopoly) that are situation immediately across the street from each other? Explain the process that reaches that "equilibrium". | + | 11. 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". |
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| | [[Category:Economics lectures]] | | [[Category:Economics lectures]] |
| | {{DEFAULTSORT: Economics Lecture 12}} | | {{DEFAULTSORT: Economics Lecture 12}} |