Time Value of money Presented by Dr. Coty Pinckney If I offer to give you 1000RMB today or 1000RMB a year from today, which would you choose? Why? Presented in 1 45-minute class period 11/9/2015 Project was introduced and chapter 11 was completed in second half of class.

Inflation Suppose in your economy, only 2 goods are consumed, rice and wheat. Consumers spend half their income on each. In year 1, the price of each is 100. Which of these year 2 prices represents a 10% inflation rate between years 1 and 2? Year 2 prices: Wheat 100, Rice 200 Year 2 prices: Wheat 100, Rice 110 Year 2 prices: Wheat 110, Rice 110 Year 2 prices: Wheat 120, Rice 100

Real interest rate With the same rice/wheat economy, suppose in Year 1 I expect prices to increase from 100 to 110 for both rice and wheat. I ask to borrow 1000RMB from you today, promising to pay you 1050RMB one year from today. Will you lend me the money? Why or why not? Would your answer change if I offered you 1100? 1200?

Central banks and interest rates In most countries – including China and the US – the central banks set some interest rates. If the interest rate on savings deposits increases, holding everything else constant, what is likely to happen to savings deposits? If the interest rate on loans increases, holding everything else constant, what is likely to happen to demand for loans? Now imagine that everything else is NOT constant. Suppose the central bank raises the interest rate by 2%, and at the same time most people expect the inflation rate to increase by 2%. Does that affect your answers above?

Key terms Time Value of Money Inflation Real Interest Rate