Reply To: Prices of Producer goods part 2


The discount formula is the complement to the compound formula. The future value of a present sum of money put on interest for one period is FV=PV(1+i). And for n periods it is FV = PV(1+i) raised to the n power. So if I lend $1,000 for one year at an annual interest rate of 0.05, then in one year my $1,000 compounds into $1,100. Therefore, if I am to receive $1,050 in one year its present value is the sum of money I would need to lend on interest now for it to accumulate to $1,050 in one year, namely $1,000. The formula is PV = FV/(1+i). And for n periods it is PV = FV/(1+i) raised to the n power.

Thus, in the lecture $5,000 to be received in one year at a 0.05 rate of interest is $5,000/1.05 = $4,762.

And $6,000 to be received in two years is $6,000/(1.1025) = $5,442