Time Value of Money

Time Value of Money

.Is a dollar today worth more than a dollar tommorow?
-YES
.Why?
  -opportunity and inflation
   - this is the reason for changing and paying interest
. Let V=future value of $
  P=present value of money
  R=real interest rate (nominal interest rate-inflation rate) expressed as a decimal
  N=years
  K=number of times interest is credited per year

Demand for money has an inverse relationship between nominal interest rates and the quantity of money demanded.

1. What happens to the quantity demanded money when interest rates increase?
Quantity demanded falls because individuals would prefer to have interest becoming assets instead of burrowed liabilities

2. What happens to the quantity demanded when interest rates decrease?
  Quantity demanded increases. There is no incentive to convert cash into interests earning assets

3. Money demand shifters
1.Change in price level
Change in income
Change in taxation that affects investment

If the FED increases the money supply a temporary surplus of money will occur at 5% interest.
The Surplus will cause the interest rates to fall to 2%

How does this affect AD?
Increase money supply-decrease interest rates_increase investment- increase AD

Decreasing money supply-how does it affect AD?
Decrease money supply-decrease interest rate-decrease investment - decrease AD