Time Preference Theory of Interest - Explained
What is the Time Preference Theory of Interest?
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Table of ContentsWhat is the Time-Preference Theory Of Interest?How does the Time-Preference Theory Of Interest Work?Academic Research on the Time-Preference Theory Of Interest
What is the Time-Preference Theory Of Interest?
The time preference theory of interest defines interest as the preference of people or a community for a dollar of present over the dollar of future income. Ordinarily, time preference refers to how goods are valued in the market given the date/time they are received. For instance, the valuation of goods received at an earlier date differs from those received at a later date. The time preference theory of interest defines interest as the price of time, hence, this shows why people have a preference for the present income over future income even if they have the same dollar amount. Irving Fisher developed this theory in his book named "The Theory of Interest s Determined by Impatience to Spend Income and Opportunity to Invest It."
How does the Time-Preference Theory Of Interest Work?
Irving Fisher defined interest as "an index of community's preference for a dollar of present over a dollar of future income." If future income and present income are presented to individuals, they would pick the present income due to interest factor. Aside from Fishers Time-Preference Theory Of Interest, there are other economic theories that explain interest using other contexts such as supply and demand of capital. The classical theory is one of these theories. This theory posits that investment drives the demand for capital while savings drive the supply of capital.