Discounting handout

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1、Econ237NotesonInterestRatesandDiscountingNaturalresourceeconomicsaddressestheallocationofresourcesovertime.Naturalresourceeconomicsdistinguishesbetweennonrenewableresourcesandrenewableresources.Coal,gold,andoilareexamplesofnonrenewableresources.Fishandwaterareexam

2、plesofrenewableresources,sincetheycanbeself-replenishing.Naturalresourceeconomicssuggestspolicyinterventioninsituationswheremarketsfailtomaximizesocialwelfareovertime,i.e.,wheremarketforcescausedepletionofnonrenewablenaturalresourcestooquicklyortooslowly,orcausere

3、newableresourceusetonotbesustainableovertime(suchaswhenspeciesextinctionoccurs).Anytimeweareconcernedabouttheallocationofresourcesovertime,weneedtothinkaboutdiscountingandinterestrates.InterestRatesOneofthebasicassumptionsofdynamicanalysisisthatindividualsareimpat

4、ient.Theywouldliketoconsumethegoodsandservicesthattheyowntoday,ratherthansavingforthefutureorlendingtoanotherindividual.Individualswilllendtheirgoodsandservicestoothersonlyiftheyarecompensatedfordelayingtheirownconsumption.Theinterestrate(oftencalledthediscountrat

5、einresourcecontexts)isthefractionofthevalueofaborrowedresourcepaidbytheborrowertothelendertoinducethelendertodelayherownconsumptioninordertomaketheloan.Theinterestrateistheresultofnegotiationbetweenthelenderandtheborrower.Thehigherthedesireofthelendertoconsumeherr

6、esourcestodayratherthantowait,and/orthehigherthedesireoftheborrowertogettheloan,thehighertheresultinginterestrate.Inthissense,theinterestrateisanequilibriumoutcome,likethepricelevelinacompetitivemarket.Evenanisolatedindividualmustdecidehowmuchofhisresourcestoconsu

7、metodayandhowmuchtosaveforconsumptioninthefuture.Inthissituation,asingleindividualactsasboththelenderandtheborrower.Thechoicesmadebytheindividualreflecttheindividual'simplicitinterestrateoftradingoffconsumptiontodayforconsumptiontomorrow.Let’sconsiderthefollowinge

8、xample.SupposeMaryownsaresource.Marywouldliketoconsumetheresourcetoday.JohnwouldliketoborrowMary'sresourceforoneyear.MaryagreestoloanJohntheresourceforo