HOUSE_OVERSIGHT_010981.jpg

The vocabulary can also include the standard distinction among stocks, flows and rates. These are only definitions, not assumptions. Stocks means value measured in money units, say dollars. This is not the same as stock in the sense of equity securities, although those can be examples. Flows means processes such as output for consumption measured in dollars per unit time. Flows are to stocks as verbs to nouns. Percent rates are flows divided by stocks, as rate of return or growth rate, and are measured in pure numbers over time such as 5% per year. Now for the fundamental theorems. Take the present value rule first. It starts from the axiom that we satisfy convergent tastes in the light of convergent predictions. In a simple case, we foresee that an asset (stock) is likely to yield a certain amount of taste satisfaction flow at a certain future time. We discount that expected amount at a time preference or time discount rate given by our taste for impatience, tempered by our taste for risk avoidance, to find its present value. Present value of the whole asset is the sum of present values of all the expected future satisfactions together. A more general case allows for transfers. The future events we foresee and discount are not always exhaust in taste satisfaction by ourselves at the time. Some might be foreseen liquidations to reinvest in other assets or to give away so that we or the donee can realize the taste satisfaction later. Either reinvestment or gift is called transfer. I call it “transfer out”, meaning out from the generating asset. Then transfer out = reinvestment + gift. (3.1) There can also be transfer in. Sometimes future realizations, in taste satisfaction or transfer out, are not explained as production by the asset as it is now. The asset might grow later by new investment from outside, and the investment in between might help explain the later yield. If an eighth-grader is destined to become a doctor, for example, her foreseen earnings as a doctor will presuppose investment in high school and college and med school in between. Chapter 3: Foundations 1/11/16 10 HOUSE_OVERSIGHT_010981