Question

Do you think that opportunity cost and inflation are linked to the time value of money? Explain and give and example .

Answer 1

Opportunity cost and inflation are directly linked with time value of money. Opportunity cost is the cost of opportunity foregone for selection of an option among the two option. For example, If one wants to invest $1,000 and he has two option, he can invest it in a FD which will give a interest of 8%, while same investment in stock market will yield 10%. The person here, decides to invest in stock market because of higher expected return, here the opportunity cost for the person is the amount that he could have earned by investing his money in a FD which is 8% of $100 = $8. If the person for some reason can only earn 5% return from stock market, then his opportunity loss will be 8% - 5% = 3%. The money has the capacity to earn, so if money is not invested elsewhere and is kept with himself, then the person is loosing money as per time value of money. This means the money received tomorrow will be lesser than the money received today. Hence, opportunity cost on a investment is the minimum return that money should get while investing elsewhere, otherwise the person will loose money due to time value of money.

Inflation, on the other hand is the general increase in prices of goods and services, which would mean a person holding a $100 bill would be able to buy less goods and services in future as compared to today. The rate at which the goods and services will become expensive is known as inflation rate. Inflation will ultimately decrease the value of dollar over time which will result in less money in hand in future as compared to today. The higher inflation rate is, the higher will be depreciation on money value.