THE THEORY OF INTEREST

§2. The Method of Comparative Advantage

The second (B) investment opportunity principle, thatof maximum present value, is of great importance and hasmany aspects not always recognized as related to oneanother. Let us restate this maximum value principle inan alternative form, thus: one option will be chosen overanother if its income possesses comparative advantagesoutweighing (in present value) its disadvantages.

To illustrate this alternative method of stating thesame principle—which method might be called themethod of comparative advantage—let us recur to theexample of the land. We found that, when the rate ofinterest was 4 per cent, the owner would elect the for-estry use, since this possessed the greatest present value.If we now compare, year by year, the income from theland when used for forestry purposes with the incomewhich it might have yielded if used in one of the otherways, as for instance farming, we shall see that in someyears there is an excess in favor of the forestry use, andin other years a deficiency, as shown in the table on thefollowing page.

Here we see that, in the first four years, there are com-parative disadvantages, a differential sacrifice, amountingin the four respective years to $450, $450, $150, $50.These are the disadvantages from the use of the land forforestry purposes as compared with its use for farming,but the disadvantages are offset later by advantages inreturn amounting to $50 each year perpetually. If prior tothe first year listed above the owner has been using theland for farming purposes and was considering the advisa-bility of changing over to forestry, he would think of thedisadvantages or sacrifices of $450, $450, $150 and $50

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