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### Course: AP®︎/College Macroeconomics>Unit 4

Lesson 1: Financial assets

# Introduction to interest

Simple interest is calculated as a percentage of the original amount borrowed (the principal) and remains the same over time. Compound interest, on the other hand, takes into account the accumulated interest as well, meaning that the amount owed grows at a faster rate and the total sum owed will be higher than with simple interest. Created by Sal Khan.

## Want to join the conversation?

• Sal, you start this video saying, "well now that you've learned one of the most useful concepts in life...." Is that from a previous video? If so, which one? This appears to be the first in the sequence. If there is one that precedes this video, can you please add an back arrow, or let me know which video that is. Thank you! You guys are great. I've learned so much from you and your team.
• Yeah the compound interest one is before do that first
• Isn't it a bit illogical to charge 10% of 121 as interest after two years, and more as time passes? I mean, you still only have the original 100, but you are paying interest for a much higher amount. You'd be much cheaper off if you paid back after each year and then simply lent 100 bucks again immediately. That way, the distribution of the money would stay the same (bank minus a hundred, you a hundred richer) and you'd only pay interest for what you actually borrowed.
How do banks justify compound loans? I mean, whether the loan has been going on for decades or just a year, the "hole" in the bank's amount of money stays the same. What difference does it make if one guy borrows some money for a really long time as compared to ten people borrowing and returning the same amount subsqeuent to each other every year? Wouldn't the scenario with many borrowers actually be worse for the bank due to the increased risk of someone not being able to pay back? Why charge the single guy more??
I feel there's something I'm missing here.
• Risk is part of it, but the "risk" of a loan is normally taken into account in the interest rate (higher risk = higher interest rate, regardless of the length of the loan). Another way to think of it is that interest is "due" every year even if you don't actually pay it. If you borrow money and do not pay the interest in a year, you are essentially now borrowing the interest payment itself on top of the principal you still have. Your loan (the principal) just got bigger by the interest payment you did not make. This sort of thing happens in practice. I have gotten loans and the fees I paid for the loan, the cost of processing the loan, and even the first year's interest payment were rolled into the loan itself, so that I paid nothing out of pocket. That way I was able to borrow the money I actually need to use for an investment but did not make any payments on what I borrowed for two years. For some investments - like construction or land development - it takes so long to be able to pay the loan back, or even make interest payments, that this is the only way to go.
• y is everything blurry i can't understand?
• Hey Uddip!

This video was made a while ago and the software wasn't quite what it is now. That might be why you're seeing it as a bit blurry. Most other videos are updated though so you shouldn't find this as too much of an issue in the rest of the course.

Hope this helps!
• Lets say that I lend out a Chemistry Textbook to someone and I say," You owe me \$300 when you return this to me next year and there is a 20% interest rate per year that you have to use the book." (Do I need to specify if it is compound or simple or can the other person assume one or the other?) If you can answer my question can you give me the reasoning behind your answer as well?
• usually when you loan something you charge normal interest ,alternatively if you charge compound interest yes you will be getting more out of it but if the person was wise he wouldn't borrow it from you in the first place (but normally people charge simple interest and if they ask then you say simple interest)
• why only resolution only 240p?
• basically, after you borrow money, the more you wait the more you will owe money. is that an accurate statement?
• of course, just like the longer you rent a house the more you will pay in rent.
• would it be smart to leave our money in the bank for ever?
• NO!
DO NOT DO THIS!
Number one, this money will be needed at one point, so, um, yeah.
Number two, scammers love those kinds of people.
And number three, inflation would decrease the value of that money.
• Can you remake this video? the quality on it makes the numbers and words practically unreadable.
• At Sal says, "But when you think about it, you're actually paying a smaller and smaller percentage of what you owe going into that year." He is referring to simple interest. I do not understand how you are paying a smaller percentage, when, by definition, you are paying the same amount every year.
• In my opinion I think...
The truth is you're actually paying a smaller and smaller percentage of interest if you don't using compound interest formula.
For example:
- I borrow you \$100 with r(interest) = 10%, after one year - if I pay you back, I will have to pay you \$110 ( This is okey )
- But what's happen when I don't pay you back, then in this case I owned you \$110 and in the end of year two If you just compound \$10 then I have to pay \$120. The interest rate will no be 10% in the year two anymore ^^ 10/110 = 9.09 %
and in year 3 will be : \$10 / 120 = 8.3 %
year 4 will be : 10/130= 7.69 %
^^
• so do we just pay ourselves when we put our money into the bank😂
• In a way yes. Albeit, a VERY small amount, but still.

I might be wrong so please look for another answer. Trust but verify.
(1 vote)