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# Economic Problem - PowerPoint PPT Presentation

Economic Problem. Evaluating Future Benefits. Income or earnings accrue in the future What are those benefits worth to us today Investing in a college or a master’s degree Situation of wrongful termination Discrimination case Value of lost future earnings. A Dollar Today or Tomorrow?.

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## PowerPoint Slideshow about ' Economic Problem' - jordan-bowman

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### Economic Problem

• Income or earnings accrue in the future

• What are those benefits worth to us today

• Investing in a college or a master’s degree

• Situation of wrongful termination

• Discrimination case

• Value of lost future earnings

Prof. Leighton

• A dollar received in the future is worth less to us than a dollar received in the present

Prof. Leighton

• A dollar held today can be invested at some market rate of interest so that by the next period it will be worth more than a dollar

• \$1.00(1.05) = \$1.05

Today’s dollar invested at 5% grows to \$1.05 tomorrow

Prof. Leighton

• How much money will you have in the next period if you invest B0 today at a rate of interest r ? B0 + r B0 = B0(1+r ) = B1

• B1 next period and B0 now are equivalent values

• Assuming you are neither present nor future oriented

Prof. Leighton

Discounted Value of B1: What Is B1 Worth Today?

• Work the simple problem backwards B0(1 + r ) = B1

• B1 received in the future is worth B0 today; solve for B0 B0= B1/(1 + r )

• B0is the discounted value of B1

Prof. Leighton

• Value now of an entire stream of future benefits or costs

• Receive benefits of B0, B1, B2,…,Bn over the current and next n periods

• Face the same interest rate, r, in each period

• The present value of benefits is given by:PVB = B0 + B1/(1 + r) + B2/(1 + r)2 + B3/(1 + r)3 +…..+ Bn/(1 + r)n

Prof. Leighton

• If the PVB > PVC, invest in master’s degree

• If the PVB < = PVC, do not invest

Prof. Leighton

• Need information on

• The direct costs of graduate school

• The earnings foregone while in graduate school

• The earnings stream of workers with a college education

• The earnings stream of workers with a master’s degree

• The appropriate rate of interest

Prof. Leighton

Ideal vs. Available Data

• Longitudinal data collected each year

• Same individuals are surveyed each year

• Some have college degree; some have master’s degree

• Follow worker over his/her work life

• Data sets tend to be small

• Synthetic Cohort

• Look at a cross-section, say 1991

• Look at the average earnings for each age level

• Assume hypothetical student will follow same earnings path as the different workers in the sample did at each age

Prof. Leighton

Indirect costs

Synthetic Cohort

Prof. Leighton

• Difference between earnings of college graduate and master’s graduate at each age

• Discounted value of that difference at each age

• Sum of the discounted values = PVB

• IF function to decide whether or not to invest

Prof. Leighton