Module 2 - Money, Time & Equivalence

2.1 Economic Environment

⮚ Consumer and Producer goods and services

Consumer goods and services - are products and services that are directly used by people to satisfy their
wants

Producer goods and services - are products and services that are used to produce consumer goods
and services or other producer goods and services

⮚ Necessities and Luxuries

Necessities – are products and services that are required to support human life and activities. These
products and services will be purchased in the same required quantities even though the
prices varies.
Luxuries - are products and services that are desired by humans and will be purchased if money is
available after the necessities have been obtained.

⮚ Demand – is the quantity of a certain commodity that is bought at a certain price at a given place and time
Elastic demand – occurs when a decrease in selling price result in a greater than proportionate in sales Inelastic
demand – occurs when a decrease in the selling price produces a lesser than proportionate increase in sales
Unitary elasticity of demand occurs when the mathematical product of volume and price are constant

⮚ Competition, Monopoly & Oligopoly

Perfect competition - is a situation where commodity or service is supplied by a number of vendors and
there is nothing to prevent additional vendors entering the market.
Perfect monopoly – is the opposite of perfect compettiton. When a huge product or service from a single
vendor and that vendor can prevent the entry of all others in the market
Oligopoly exists when there are few suppliers of a product or service. The action of one supplier will
affect the others.

⮚ The Law of Supply & Demand

“Under conditions of perfect competition, the price at which a given product will be
supplied and purchased is the price that will result in the supply and the demand being
equal”

⮚ The Law of Diminishing Returns

“When the use of one of the factors of production is limited, either in increasing cost
or absolute quantity, a point will be reached beyond which an increase in the variable
factors will result in a less than proportionate increase in output”

2.2 CASH FLOWS

Cash-flow diagrams for economic analysis are graphical representation of cash flows drawn on a time scale. A
receipt or positive cash flow (cash inflow) is denoted by an upward arrow and a negative cash flow (cash outflow) is
denoted by a downward arrow.

receipt (positive cash flow/cash inflow

disbursement (negative cash flow/cash outflow)

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 Example: A loan of P100 at simple interest of 10% will become P150 after five years.

Cash flow diagram on the viewpoint of the lender Cash flow diagram on the viewpoint of the borrower

2.3 INTEREST

2.3-1 Simple Interest

I = Pni (eqn. 2.1)

F=P+I

F = P ( 1 + ni) (eqn. 2.2)

where:
I = interest
F = accumulated amount or future worth
n = number of interest periods
P = principal or present worth
i = rate of interest per interest period

a) Ordinary simple interest - interest computed based on 12 months (1 month = 30 days) or

360 days/year

b) exact simple interest- interest computed based on number of days per year
365 days or 366 days for a leap year
Example 2-1:
Determine the ordinary simple interest on P700.00 for 8 months and 15 days of the rate of interest is 15%.

Given: P = 700
n = 8 months & 15 days
rate of interest = 15%
Reqd: I (ordinary simple interest)
Solution:
n = 8(30) + 15 = 255 days

using eqn. 1: I = Pni

= (700)(
)(0.15/yr)
I = 74.38

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 Example 2-2:
Determine the exact simple interest on P500.00 for the period January 10 to October 28, 2022 at 16% interest.

Given: P = 500
Period : Jan 10 – Oct 28, 2022
rate of interest = 16%

Reqd: I (exact simple interest)

Solution:
no. of days no. of days
Jan 10-31 = 21 June = 30
Feb = 29 July = 31
March = 31 Aug = 31
April = 30 Sept = 30
May = 31 Oct 1-28= 28
total no. of days = 292 days

using eqn. 1: I = Pni

= (500)(
)(0.16/yr)
I = 63.83
Example 2-3: What will be the future worth of money after 14 months if a sum of 10,000.00 is invested today at a
simple interest rate of 12% per year?

Given: P = 10,000.00
n = 14 months
rate of interest = 12%/yr
Reqd: I (ordinary simple interest)
Solution:

using eqn. 2: F = P(1 + ni)

= (10,000.00)(
)(0.12/yr)
F = 11,400.00

2.3-2 Compound Interest

Compound interest scheme is the interest calculated based on the total amount at the end of the previous period.
This amount includes the original principal plus the accumulated interest that has been left in the account
Interest Period Principal at the Interest earned Amount at the end
beginning of period during period of period

1 P Pi P+Pi = P(1+i)

2 P(1+i) P(1+i)i P(1+i) + P(1+i)i = P(1+i)2

3 P(1+i)2 P(1+i)2i P(1+i)2+ P(1+i)2i =

P(1+i)3

…….. …. …. …

n P(1+i)n-1 P(1+i)n-1i P(1+i)n

F = P(1+i)n(eqn. 2.3) ; (1+i)n = single payment compound factor

F = P(F/P, i%, n) (eqn. 2.4) ;

 P = F(1+i)-n(eqn. 2.5)

P = F(P/F, i% ,n) (eqn. 2.6)

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Rates of interest - is the amount earned by a unit principal per unit time. It is also the cost of borrowing money.

Types of rates of Interest:

a) Nominal rate of interest specifies the rate of interest and a number of interest periods in one (1)

i=
year (eqn. 2.7)

where: i = rate of interest per interest period

r = nominal interest rate
m = number of compounding periods per year

Example 1: If the nominal rate of interest is 10% compounded quarterly,

then, i =
= 2.5%

Example 2 :

b) Effective rate of interest is the actual or exact rate of interest on the principal in one year.
F
 Example 1 :
If ₱1.00 is invested at a nominal rate of 15% compounded quarterly, after one year, this will become:

₱1.00 (1 +
)4= ₱1.1586 ; the actual interest earned is 0.1586
The rate of interest after 1 year is 15.86%, hence

Effective interest rate = F1 – 1= (1 + i)n– 1 (eqn. 2.8)

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Where: F1 = the amount after 1 year
Example 2:
Find the nominal rate which if converted quarterly could be used instead of 12% compounded monthly.
What is the corresponding effective rate?

Solution: Let r = the unknown nominal rate

Strategy: For two or more nominal rates be equivalent, their corresponding effective rates must be

equal; Nominal rate Effective rate

r% compounded quarterly ( 1 +
)4– 1

12% compounded monthly ( 1 +

)12– 1

Equating both effective rates:

(1+ – 1 = ( 1 + 12– 1 ( 1 + 4
)4 ) ) = (1 + 0.01)12

r = 0.1212 or 12.12% compounded quarterly

Example 3:
Find the amount at the end of two years and seven months if ₱1000.00 is invested ay 8%
compounded quarterly using simple interest for anytime less than a year interest period.

Given: P = ₱1,000.00 i = 8% compounded quarterly

n = 2 years & 7 months (simple interest for less than a year interest period)

Required: total amount at the end of 2 yrs & 7 mos. (F)

Solution:
 For compound interest: i =
= 2% ; n = (2) (4) = 8

For simple interest: i = 8% ; n =

Using eqn. 2.3; F1 = P(1+i)n = ₱1000 (1 + 0.02)8= ₱1171.66

(1+ ni) = ₱1171.66 [1+

Using eqn. 2.2; F2 = F1 (.08)] = ₱1,226.34

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Example 3:
A ₱2000 loan was originally made at 8% simple interest for 4 years. At the end of this period the loan
was extended for 3 years, without the interest being paid, but the new interest rate was made 10% compounded
semi-annually. How much should the borrower pay at the end of 7 years?

Given: P = ₱2000 at 8% simple interest for 4 years

Loan was extended for another 3 years without interest being paid,
new interest 10% compounded semi-annually
Reqd: F at the end of 7 yrs
Solution:

Using eqn. 2.2; F4 = P(1+ ni) ₱2000[1 + (4)(0.08)] = ₱2640

₱2640 [1+
Using eqn. 2.3; F7 = F4(1+i)n )6= ₱3537.86

Note: n = 6 [the time is 3 yrs, compounded semi-annually]

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