Three Ways to Determine the Discount Rate
Three Ways to Determine the Discount Rate
This chapter presents the simple two-period model that is used in classical economics textbooks to examine the problem of consumption, saving, and investment in a competitive economy. This model is a reminder of the key role of the interest rate for the determination of economic growth. Its equilibrium level balances the demand and the supply of liquidity, which are themselves characterized by time preferences and investment opportunities. From a simple arbitrage argument, any new investment opportunity in the economy should be evaluated by using the interest rate as the rate at which the future benefits of the project should be discounted.
Keywords: two-period model, competitive economy, interest rate, economic growth, liquidity, new investment opportunities
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