Here is a brief example that explain the impact of interest rates. We’ll assume two periods for simplicity sake. Period 1 (Year 1) will be the CURRENT period, and Period 2 (Year 2) will be the FUTURE period.
Other notes for this example: A consumer who earns $30,000/year; an interest rate of 5% for savings and borrowings.
|
Case 1: (All income consumed currently) |
Case 2: (All income consumed in the future) |
|
|
Cost to Consume Period 2 Income in Period 1 |
$1428.57 = (Consumer borrows $28,571.43 @ 5%) |
|
|
Income Earned By Saving Period 1 Income to Spend In Period 2 |
$60,000- ($1,428) yr1= $58,571.43 |
$30,000*.05 = $1500 30,000 Year 1 saved 30,000 Year 2 saved 1,500 interest |
|
Total Income Available |
$58,571.43 (Spent in Period 1)
Y0 + (Y1 / 1+ r) |
= $61,500.00 (Spent in Period 2)
Y1 + Y0 (1 + r) |