§5. Specifications of Income

In the above schematic picture only two periods of time are represented. In actual life there are many periods—an indefinite number of them. Theoretically there might be a rate of interest connecting every pair of possible dates. For instance, there might be a rate of interest between the present and one year hence, another between one year hence and two years hence, and so on, all these rates being quotable in today's markets. In practice no rates are actually quoted except those connecting the present (which, of course, merely means a future date near the present) with several more remotely future dates. A rate on a five year contract may be considered as a sort of an average of five theoretically existing rates, one for each of the five years covered.

Except when the contrary is specifically mentioned, it will henceforth be understood, for the sake of simplicity, that there is only one rate of interest, the rate of interest, applicable to all time intervals. This may be most conveniently pictured to mean the rate connecting today with one year hence. Even this rate of interest connecting two specific dates separated by one year depends on (or, in technical terminology, is a function of) conditions not only at these two dates but at many other dates. When it is said that the impatience of an individual depends on his future income stream, it is meant that the degree of his impatience for, say, $100 worth of this year's income over $100 worth of next year's income depends upon the entire character of his expected income Edition: current; Page: [71] stream pictured as beginning today and extending into the indefinite future, with specific increases or decreases at different periods of time.

If we wish to be still more meticulous, we may note that a person's income stream is made up of a large number of different elements, filaments, strands, or fibers, some of which represent nourishment, others shelter, others amusement, and so on—all the components of real income. In a complete enumeration of these elements, we should need to distinguish the use of each different kind of food, and the gratification of every other variety of human want. Each of these constitutes a particular thread of the income stream, extending out from the present into the indefinite future, and varying at different points of time in respect to size and probability of attainment. A person's time preference, or impatience for income, therefore, depends theoretically on the size, time shape, and probability (as looked at in the present) of this entire collection of income elements as we may picture them stretching out into the entire future.

In summary, we may say then that an individual's impatience depends on the following four characteristics of his income stream:

• 1. The size (measured in dollars) of his expected real income stream.
• 2.Its expected distribution in time, or its time shape—that is, whether it is constant, or increasing, or decreasing, or sometimes one and sometimes the other.
• 3.Its composition—to what extent it consists of nourishment, of shelter, of amusement, of education, and so on.
• 4.Its probability, or degree of risk or uncertainty.

We shall consider these four in order.

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