Economics of the Time Value of Money

Dollar Today

A dollar today is worth more than a dollar in the future. This is why we have something called interest. If you invest 100 dollars today and are promised 5% interest in the future or in one year; the value is 105 dollars. This might sound great but what if the inflation rate was 6% in one year. Your real interest rate would be 5%-6%=-1% interest. Some would say that you could spend the 100 dollars today, and in this circumstance this might be best. There is a formula for future value with simple interest: Future Value= Present Value(1+interest)raised to time in years. This is just a basic way to see the time value of money. Money becomes less valuable in the future unless the interest is high enough to overcome the inflation rate.