§4. Interest and Price Theory

The preference of any individual for early over deferred income depends upon his present as compared with his prospective income and corresponds to the ordinary theory of prices, which recognizes that the marginal want for any article depends upon the quantity of that article available. Both propositions are fundamental in their respective spheres.

The relationship of these problems, and others, may be schematized roughly as shown in Chart 4 which follows.

In this chart A and B represent present prices of enjoyable goods; and A' and B' prices of future enjoyable goods. A and A' refer to different years in the same place, say New York; B and B' are similar except that they relate to a different place, say London.

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All problems of local prices, exchange, and interest, act and react on each other in many ways. The problem of "time" foreign exchange, or forward foreign exchange, is indicated by the diagonals, and involves both interest and foreign exchange, i.e., both a time to time factor and a place to place factor combined in the same transaction. Both exchange and interest rates, as well as local prices, would be, theoretically, combined if, say, present New York wheat were quoted in terms of future London coal.

In this book, for simplicity, the problems of price determinations, in one place and at one time, are supposed to have been solved.33 We start with the values of the Edition: current; Page: [70] items in the income stream ready made. Likewise we neglect the problem of foreign exchange; we are studying only the problem of interest.