Finances were the main focus of Chapter 27. Mankiw’s teaching of the present/future value of money was pretty easy to understand mathematically. Conceptually with the risk aversion and insurance market (with its risk adverse selection) was explained well and left little room for confusion. Overall, this chapter was simple in its ideas and wasn’t hard to read. I would give this a difficulty level of 1.5/3. In order to calculate the present value and future values, you need to have the interest and we assume that the interest rate will not change as much as it has recently.
I think this chapter will have more real life applications as we are into Macro, this chapter teaches us how to diversify our risk and spread it out instead of dumping it all on one item. There is no way to get rid of risk completely, but there is a way to minimize it. The present value states that a dollar in the future is less valuable than a dollar today, and it gives a way to compare sums of money at different points in time. This is because due to savings earn interest, a sum of money in present day is more valuable than the same sum of money in the future. The present value of any future sum is the amount that would be needed today, given prevailing interest rates, to produce that future sum.
The book says that due to diminishing marginal utility, most people are risk averse. Risk-averse people can reduce risk by buying insurance, diversifying their holdings, and choosing a portfolio with lower risk and lower return. The value of an asset equals the present value of the cash flows the owner will receive. According to the efficient markets hypothesis, financial markets process available information rationally, so a stock price always equals the best estimate of the value of the underlying business.
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