Macroeconomics
Assumingthatinthepreviousexamplethenominalinterestrateis4%andtheinflationrateis1%,wecan deduce that the real interest rate is 3%.
Therefore, PV = $220/(1 + 0.03)² ≈ $207.37.
This means that the $220 that will be received in two years is in reality worth around $207.37.
Thepresentvalueofmoneydemonstrateshowinterestratescanbe used to compare the value of money received today tothevalueof moneyreceivedinthefuture. Thisconcepthelpsdeterminehowmuch moneywouldbeneededrightnowtobeequallywelloffashavingmore moneyinthefuture.Insimpleterms,ithelpsusunderstand thecurrent worth of future money . This is important because the money held in hands today is typically worth more than the same amount of money that might be received in the future. Ontheotherhand,the futurevalue ofmoneyillustrateshowmoneycangrowovertimewhensavedor invested. FV = PV (1 + i) ⁿ For instance,ifoneinvests$100inasavingsaccountthatpaysa5%annualinterestrateandwantsto know how much this amount will grow in 3 years, the future value should be calculated as follows: FV = $100 (1 + 0.05) ≈ $115.76. So, this is theamount this person will have in three years. ³ C. Measures of Money Supply Afterestablishingtheconceptofmoney,thenextstepistomeasureaneconomy'smoneysupply.Given thatvariousassetscanhavethesamefunctionsasmoney,economistshavedeviseddistinctlabelsfor various measures of money to establish a clear boundary, designating what constitutes money and distinguishing it from other assets. Monetaryaggregates representanoverallmeasureofthemoneysupplythatincludes differentforms of money categorized based on liquidity (how easy they can be converted into cash). The most commonly used aggregates or measures of money supply are M1 and M2. 1. M1 (Narrow Money or Transactions Money): M1 is the narrowest measure of moneysupply, focusingonthe mostliquidandreadilyaccessible formsofmoney.Inotherwords,thisisthe money that can be directly used to buy things (i.e.,fortransactions).Itincludesthefollowing components: ➔ Currency in Circulation: Thisisthephysicalcash(coinsandpapermoney) heldbyindividuals and businesses in an economy. It represents money that is immediately available for transactions outside the central banks and vaultsof depository institutions.
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