Question

What is the difference between static efficiency for one period in time and dynamic efficiency over multiple periods? What is the discount rate and how is it used to compare a future dollar benefit to a present-day benefit? Suppose that you could have a sum of $1,000 today or 1,500 next year and the interest rate happened to be 10%. Which would be more valuable? Show your work.

Answer 1

Static efficiency is related with the efficienct combination of all inputs at particular point of time. It is all about the efficiency of a firm or investment at certain point of time. In evaluating a project in static efficiency we need to take all cash flows of that time only. Cash flows over the time period or accross the time period is not to be taken into account.

In dynamic efficiency the combination of inputs changes accross the time period. The dynamic efficiency happens due to technological and other changes. The cost and benefits over different time periods are to be taken for the evaluation of any investment.

Discount rate is the rate in which future cash flows are to be compared with the present cash flows. It is also called as interest rate. It is also can be said to be the rate of return of an investment.

If you wish to have 10000 at the 10th from now what amount you need to invest at present at a discount rate of 10%.

In this example the Future value (F) is 10000

Rate of discount is 10%, Life of the investment is 10Years.

Calculating the Present Value of 10000

P = F (P/F, i, n)

P = 10000(P/F, 10%, 10)

P = 10000(.3855) = 3855

Suppose i have 1000 now or today and 1500 next year at a the interest rate of 10%

Calculating the PV of 1500

PV = F (P/F, i, n)

PV = 1500 (P/F, 10%, 1)

PV = 1500 (.9091) = 1363.65

1500 is more valuable than 1500 next year at an interest rate of 10%