Austrian or Agio Theory

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Austrian or Agio Theory
This theory is also caIJed Psychological Theory of interest. First advanced by J Rae in 1834. this theory was given its final shape by 80Iun Bawerk of the Austrian school of economists. It became popular later among some American economists, like Fisher, with slight rnodific~s. The Theory. The gisl of the theory of Bohm Bawerk. is that interest arises because people prefcr present goods to future goods, and that, therefore. there is an ‘agio’ or premium on ~t goods. One bird in hand is said to be worth two in the bush. The present gratification is attached greater importance than” the future satisfaction.

In other words, future satisfactions when viewed from the present angle undergoes a discount. Interest is this discount which must be paid in order to induce people to lend money or postpone present satisfactions to a future data. That is. interest is intended to equate future satisfaction with present satisfaction. To induce a person to part with Rs, 100 now, it is not enough to give him a promise of the return of only Rs.IOO after a year. The borrower must pay more, otherwise the lender will feel that he is a loser. The human mind is so constituted that there is commonly an under-valuation of the future purchasing power as compared with the present purchasing power. Why do people prefer present satisfaction to future sati sfaction? Bohm Bawerk gave three reasons for this fact. One is the “prospective under-estimate for the future”. The future is less clearly perceived than the present. It is uncertain. In the second place, present wants are felt more keenly than the future wants. The result is that the demand for present goods is greater than that for future goods. Thirdly, present goods possess “a technical superiority over future goods.” This is so because the passage of time allows the use of more round about methods of production, which’ are more productive. Another reason is that one may hope to improve his economic position in future as a result of which the marginal utility of his income will decline. He will, therefore, prefer to use his income at the present when the marginal utility of his income is high. There is still another reason for a consumer to prefer present satisfaction to future satisfaction. He may expect growth of the economy making more and better goods and services available when the general standard of living will be higher indicating declining marginal utility of money. These reasons, however, do not apply to all, at any rate, to the same extent

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Austrian or Agio Theory