Price theory

Lottery Economics

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Imagine that there is a man who won 20 million dollars in the lottery The Sweepstakes office in his town tells him that he will receive the money in instalment : 4 million dollars per year for 5 years . It might seem like a good deal but is it really what it seem ? The answer to this question might just be difficult to believe

It might seem that time is insignificant in this set-up , but it isn 't

In economics , there is a concept called present value , which is the notion that a dollar paid to you one year from now is less valuable than a dollar paid to you today . Present value can be determined if the interest rate of the instalment payment is given . For the case of our millionaire , let 's assume the current interest rate is 10

To further illustrate this point , it is good to find the present value using the following formula : PV CF (1 i )n where PV is the present value , CF is the cash flow for number of years , is the interest rate and n is the number of years

Computing the present value of the lottery winner : 1 million in 5 years at 10 interest 2 ,732 ,053 .821 2 , 483 ,685 .232

Adding these payments for each year , the man would get 11 ,890 ,147 .02 million dollars at the end of the five...