Interest measurement

The model question

Before using a formula, decide what earns interest. In simple interest, only the original principal earns interest. In compound interest, the accumulated balance becomes the base for the next period.

Two accumulation models

For principal P, annual rate i, and time t:

• Simple: A = P(1 + it)
• Effective compound: A = P(1 + i)^t

The formulas may look similar, but their growth assumptions differ.

Checkpoint

If previously earned interest itself earns interest in the next period, use a compound model—not a simple-interest model.