Teaching Fisher's Theory of Interest in a Simple Auction Setting

Theories of the interest rate begin with either the supply and demand of loanable funds or the stock of investment opportunities and their rates of return. Fisher's (1930) two-period model has an undifferentiated stock of investment opportunity. Teaching the standard Fisher theory of interest to undergraduates is generally difficult and not very successful. The graphical version with its double tangency solution to the production-consumption problem is only convincing to undergraduate economics or finance majors with unusual mathematical sophistication. Moreover that treatment, found in Hirschleifer (1970) and in Fama and Miller (1972) as well as in later treatments like Howe and Gronewoller (1990), has no capital goods and no explicit capital market. The model I propose requires no graphs and puts students in the position of being present at the auction for credit to see how simple maximizing behavior determines the rate of interest and how outside factors raise and lower it.