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

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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

Prof. Leighton

A Dollar Today or Tomorrow?

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

Prof. Leighton

A Dollar Today or Tomorrow?

- 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

Investing at a Rate of r

- 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

Present Value

- 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

Is a Master’s Degree a Sound Financial Investment?

- If the PVB > PVC, invest in master’s degree
- If the PVB < = PVC, do not invest

Prof. Leighton

Planning the Worksheet

- 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

Needed Formulas

- 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

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