FACULTY OF SCIENCE AND AGRICULTURE

Department of Mathematical Sciences

Mathematics and Statistics for Com-

merce

SSTT121

Compiled by S SIBIYA & MW KUBHEKA

1
Exponential Functions
Exponential function plays an important role in many real-world ap-
plications, as you will see throughout this chapter. Observe that 𝒃
is an important positive number and 𝒏 is any real number, the expres-
sion 𝒃𝑛 is a real number. This enables us to define an exponential
function as follows:

1.1 Exponential Function

The function defined by:
𝑓(𝑥) = 𝑏 𝑥 (𝑏 > 0, 𝑏 ≠ 1)

is called an exponential function with the base 𝒃 and exponent 𝒙. The

domain of 𝑓 is the set of real numbers.
Notice that the 𝑥 is now in the exponent and the base is a fixed
number. This is exactly the opposite from what we’ve seen to this
point. To this point the base has been the variable, 𝑥 in most
cases, and the exponent was a fixed number. However, despite these
differences these functions evaluate in the same way as those that
we are used to. We will see some examples of exponential functions
shortly.
Before we get too far into this section, we should address the
restrictions on b. We avoid one and zero because in this case the
function would be,𝑓(𝑥) = 0𝑥 = 0 and 𝑓(𝑥) = 1𝑥 = 1 and these are
constant functions and won’t have many of the same properties
that general exponential functions have.
Next, we avoid negative numbers so that we don’t get any complex
values out of the function evaluation. For instance, if we allowed
1
1
𝑏 = −4 the function would be, 𝑓(𝑥) = (−4)𝑥 ⇒ 𝑓 ( ) = (−4)2 = √−4
2
and as you can see there are some function evaluations that will
give complex numbers. We only want real numbers to arise from
function evaluation and so to make sure of this we require that 𝑏

2
not be a negative number. Now, let’s look at a couple of graphs.
We will be able to get most of the properties of exponential
functions from these graphs.
Example 1
1 𝑥
Sketch the graph of 𝑓(𝑥) = 2𝑥 𝑎𝑛𝑑 𝑔(𝑥) = ( ) on the same axis
2
system.
Solution
Okay, since we don’t have any knowledge on what these graphs
look like we’re going to have to pick some random values of 𝑥
and do some function evaluations. Function evaluation with ex-
ponential functions works in the same manner that all function
evaluation has worked to this point. Whatever is in the paren-
thesis on the left we substitute into all the 𝑥 s on the right
side. Here are some evaluations for these two functions,

𝑥 𝑓(𝑥) = 2𝑥 1 𝑥
𝑔(𝑥) = ( )
2
-2 1 1 −2
𝑓(−2) = 2−2 = 2 𝑔(−2) = ( )
2 2
1 2 2
= =( )
4 1
=4
-1 −1
1 1 1 −1
𝑓(−1) = 2 = ( ) 𝑔(−1) = ( )
2 2
1 2 1
= =( )
2 1
=2
0 𝑓(0) = 20 = 1 1 0
𝑔(0) = ( ) = 1
2
1 𝑓(1) = 21 = 2 1 1 1
𝑔(1) = ( ) =
2 2
2
2 𝑓(2) = 22 = 4 1 1
𝑔(2) = ( ) =
2 4

3
 f(x)=2^x g(x)=(0.5)^x

4 1/2
4
3 1/2
3
2 1/2
2
1 1/2
1
1/2
0
-2.5 -2 -1.5 -1 -0.5 0 0.5 1 1.5 2 2.5

For example, the exponential function with base 2 is the function

𝑓(𝑥) = 2𝑥
With domain (−∞, ∞). The values of 𝑓(𝑥) for selected values of 𝒙
follow:
3 3 1
𝑓(3) = 2 = 8 𝑓 ( ) = 2 = 2 ∙ 22 = 2√2 𝑓(0) = 20 = 1
3 2
2
1 2 2 1 1
𝑓(−1) = 2−1 = 𝑓 (− ) = 2−3 = 2 = 3
2 3
23 √4
Computations involving exponentials are facilitated by the laws of
exponents. The laws were stated in Section 10.1, and you might want to
review the material there. For convenience, however, we will restate
these laws.
Laws of exponents
Let 𝑎 and 𝑏 be positive numbers and let x and y be real numbers. Then,

1. 𝑏 𝑥 𝑏 𝑦 = 𝑏 𝑥+𝑦
𝑏𝑥
2. = 𝑏 𝑥−𝑦
𝑏𝑦
3. (𝑏 𝑥 )𝑦
= 𝑏 𝑥𝑦
4. (𝑎𝑏)𝑥 = 𝑎 𝑥 𝑏 𝑥
𝑎 𝑥 𝑎𝑥
5. ( ) = 𝑥
𝑏 𝑏
4
Properties of 𝑓(𝑥)=𝑏 𝑥

1.The graph of 𝑓(𝑥) will always contain the point (0,1).Or put another
way, 𝑓(0) = 1 regardless of the value of b.
2. For every possible 𝑏 we have 𝑏 𝑥 > 0.Note that this implies that
𝑏 𝑥 ≠ 0.
3. If 0 < 𝑏 < 1 then the graph of 𝑏 𝑥 will decrease as we move from
1 𝑥
left to right. Check out the graph of ( ) above for verification of
2
this property.
4. If 𝑏 > 1 then the graph of 𝑏 𝑥 will increase as we move from left
to right. Check out the graph of 2𝑥 above for verification of this
property.
5. If 𝑏 𝑥 = 𝑏 𝑦 then 𝑥 = 𝑦

All these properties except the final one can be verified easily from
the graphs in the first example. We will hold off discussing the final
property for a couple of sections where we will be using it.
As a final topic in this section we need to discuss a special exponen-
tial function. In fact, this is so special that for many people this
is the exponential function. Here it is,
𝑓(𝑥)=𝑒 𝑥
where 𝑒 = 2.718281828 ⋯. Note the difference between 𝑓(𝑥)=𝑏 𝑥 and
𝑓(𝑥)=𝑒 𝑥 . In the first case 𝑏 is any number that meets the restrictions
given above while 𝑒 is a very specific number. Also note that 𝑒 is not
a terminating decimal.
This special exponential function is very important and arises natu-
rally in many areas. As noted above, this function arises so often that
many people will think of this function if you talk about exponential
functions. We will see some of the applications of this function in
the final section of this chapter. Let’s get a quick graph of this
function.

5
Example 2
Sketch the graph of 𝑓(𝑥)=𝑒 𝑥 .
Solution
Let’s first build up a table of values for this function.
𝑥 -2 -1 0 1 2
𝑓(𝑥) 0.1353⋯ 0.3679⋯ 1 2.718⋯ 7.389⋯

To get these evaluation (except for 𝑥 = 0 ) you will need to

use a calculator. In fact, that is part of the point of this
example. Make sure that you can run your calculator and verify
these numbers.
f(x)=e^x
8

0
-2.5 -2 -1.5 -1 -0.5 0 0.5 1 1.5 2 2.5

Notice that this is an increasing graph as we should expect since 𝑒 =

2.718281827 > 1.
There is one final example that we need to work before moving onto the
next section. This example is more about the evaluation process for
exponential functions than the graphing process. We need to be very
careful with the evaluation of exponential functions.

6
Example 3
Sketch the graph of 𝑔(𝑥) = 5𝑒 1−𝑥 − 4. Solution
Solution
Here is a quick table of values for this function.
𝑥 -1 0 1 2 3
𝑔(𝑥) 32.945⋯ 9.591⋯ 1 -20.161⋯ -3.323⋯
Now, as we stated above this example was more about the evalua-
tion process than the graph so let’s go through the first one
to make sure that you can do these.
𝑔(−1) = 5𝑒 1−𝑥 − 4
= 5𝑒 1−(−1) − 4
= 5𝑒 2 − 4
= 5(7.89) − 4
Notice that when evaluating exponential functions, we first need
to do the exponentiation before we multiply by any coefficients
(5 in this case). Also, we used only 3 decimal places here since
we are only graphing. In many applications we will want to use
far more decimal places in these computations.
g(x)=5e^(1-x)-4
35

30

25

20

15

10

0
-1.5 -1 -0.5 0 0.5 1 1.5 2 2.5
-5

-10

Notice that this graph violates all the properties we listed above.
That is okay. Those properties are only valid for functions in the form
𝑓(𝑥) = 𝑏 𝑥 𝑎𝑛𝑑 𝑓(𝑥) = 𝑒 𝑥 . We’ve got a lot more going on in this func-
tion and so the properties, as written above, won’t hold for this
function.

7
Tutorial 1
1. Use the laws of exponents to simplify the following expressions
below.
7⁄ −1⁄
a) 4 16 2 × 16
5
8 ⁄3
b) −1⁄
8 3
−1⁄
4 2
c) (64 ⁄3 )
−1⁄
d) (16 × 81) 4
1 4
3 ⁄2
e) ( 1 )
2 ⁄3

2.Let𝑓(𝑥) = 22𝑥−1 . 𝐹𝑖𝑛𝑑 𝑡ℎ𝑒 𝑣𝑎𝑙𝑢𝑒 𝑜𝑓 𝑥 𝑤ℎ𝑒𝑟𝑒 𝑓 (𝑥 ) = 16.

3.Solve the equation for 𝑥.
a) 22𝑥−1 × 2−3 = 2𝑥−1
b) 62𝑥 = 64
1 𝑥−2
c) 8𝑥 = ( )
32
2 1
d) 3𝑥−𝑥 =
9𝑥
e) 3 − 12 × 3𝑥 + 27 = 0
2𝑥

f) 22𝑥 − 4 × 2𝑥 + 4 = 0
4.Sketch the graph of the exponential function 𝑓(𝑥) = 22𝑥 .
Where−1 < 𝑥 ≤ 3.

8
5.According to a study conducted in 2000, the projected number
of Web (in billion) address is approximated by the function
𝑁(𝑡) = 0.45𝑒 0.5696𝑡 (0 ≤ 𝑡 ≤ 5)
Where 𝑡 is measured in years, with 𝑡 = 0 corresponding to 1997.
a) Complete the following table by finding the number of Web
addresses in each year:
Year 0 1 2 3 4 5

Number
of Web
Ad-
dresses
(bil-
lion)
b) Sketch the graph of N.
c) If results of the study showed that 200 automatic vehicles
have GPS. How long will it take the tracker company to in-
stall 200 GPS?
6.The alternative minimum tax was created in 1969 to prevent the
very wealthy from using creative deduction and shelter to avoid
having to pay anything to the Internal Revenue Service. But it
has increasingly hit the middle class. The number of taxes sub-
ject to an alternative minimum tax is projected to be:
35.5
𝑁(𝑡) = (0≤ 𝑡 ≤ 6)
1+6.89𝑒 −0.8674𝑡

Where N(t) is measured in millions and t is measured in years,

with t=0 corresponding to 2004. What is projected number of tax-
payers subjected to alternative minimum tax in 2010?
7.Sketch each of the following.
a) 𝑓(𝑥) = 6𝑥
b) 𝑔(𝑥) = 6𝑥 − 9
c) 𝑔(𝑥) = 6𝑥+1

9
8. Sketch each of the following.
a) 𝑓(𝑥) = 𝑒 𝑥
b) 𝑔(𝑥) = 𝑒 𝑥−3 + 6
TUTORIAL 1 CONTINUE ON PAGE 21 to 22

1.2 Logarithmic Functions

In this chapter, you will learn

➢ the definition of logarithmic function as the inverse of

the exponential function
➢ to write equivalent logarithmic and exponential expres-
sions
➢ properties of logs
➢ use logarithmic functions to solve equations involving ex-
ponential functions

In this chapter we examine exponential and logarithmic func-

tions. We will need these functions in the next chapter, when
examining financial calculations.

1.2.1.Logarithm
Definition: If 𝑥 and 𝑏 are positive numbers and 𝑏 ≠ 1then the loga-
rithm of 𝑥 to the base 𝑏 is the power to which 𝑏 must be raised to
equal 𝑥. It is written log 𝑏 𝑥. In algebraic terms this means that the
logarithm (base b) function, written log 𝑏 (𝑥) , is the inverse of the
exponential function (base b), 𝒃𝒙 .
𝒚 = 𝐥𝐨𝐠 𝒃 (𝒙) is equivalent to 𝒃𝒚 = 𝒙
In general, the statement 𝑏 𝑎 = 𝑐 is equivalent to the statement
log 𝑏 (𝑐) = 𝑎.
Note: The base 𝑏 must be positive: 𝑏 > 0

10
Since log is a function, it is most correctly written as log 𝑏 (𝑐),
using parentheses to denote function evaluation, just as we
would with f(c). However, when the input is a single variable or
number, it is common to see the parentheses dropped and the ex-
pression written as log 𝑏 (𝑐) .

Example 1:
Write these exponential equations as logarithmic equations:

1
a) 3𝑥 = 81 b) 𝑥 −3 = 64 c) 10−3 =
1000

Solution:
1
a) 𝑥 = log 3 81 b) −3 = log 𝑥 64 c) log10 ( ) = −3
1000

Example 2:
Write these logarithmic equations as exponential equations:

1
a) log 6 36 = 𝑥 b) log 6 36 = 2 c) log 6 (√6) =
2

Solution
1
a) 6 𝑥 = 36 b) 62 = 36 c) 62 = √6

Strategy to solve simple logarithm functions

1. If the logarithm is NOT in base 10, then convert it into an
exponential form
2. If 𝑦 is easily recognized as the power of the base, 𝑎 or
some other base, then write both sides of the exponential
equation in the same base. Equate the exponents and solve.

Example 3:
Solve the following logarithm equations
1
a) log 8 𝑥 = 2 b) log 𝑥 =5 c) log 5 5√5 = 𝑥
243

11
 1 1
82 = 𝑥 𝑥5 = 5𝑥 = (5)1 (5)2
243
1 5 3
𝑥 = 64 𝑥5 = ( ) 5𝑥 = (5)2
3
1 3
𝑥= 𝑥=
3 2

Natural Logarithms

Of all possible bases for logarithms, we will see that the most
convenient choice of a base is the number 𝑒. The logarithm with
base is called the natural logarithm and has a special notation:

𝐥𝐨𝐠 𝒆 𝒙 = 𝐥𝐧 𝒙

If we put 𝑏 = 𝑒 and replace 𝑙𝑜𝑔𝑒 with “ln” in (6) and (7), then
the defining properties of the natural logarithm function become

𝐥𝐧 𝒙 = 𝒚 ⟺ 𝒆𝒚 = 𝒙

𝐥𝐧(𝒆𝒙 ) = 𝒙 𝒙∈ℝ

𝒆𝐥𝐧 𝒙 = 𝒙 𝒙>𝟎

If we set 𝑥 = 1, we get

𝐥𝐧(𝒆) = 𝟏

The following formula shows that logarithms with any base can be
expressed in terms of the natural logarithm. For any positive
number 𝑏(𝑏 ≠ 1), we have

𝐥𝐧 𝒙
𝐥𝐨𝐠 𝒃 𝒙 =
𝐥𝐧 𝒃

LAWS OF LOGARITHMS AND EXPONENTIAL

Logs and exponents have some very useful properties which follow
from their definition and the equivalence of the logarithmic

12
form and exponential form. Some useful properties are as fol-
lows:

Exponential Laws Logarithm Laws

(𝑎𝑚 )(𝑎𝑛 ) = 𝑎𝑚+𝑛 log 𝑎 𝑥 + log 𝑎 𝑦 = log 𝑎 (𝑥 𝑦)

𝑎𝑚 𝑥
= 𝑎𝑚−𝑛 log 𝑎 𝑥 − log 𝑎 𝑦 = log 𝑎 ( )
𝑎𝑚 𝑦
(𝑎𝑚 )𝑛 = 𝑎𝑚𝑛 log 𝑎 𝑥 𝑦 = 𝑦 log 𝑎 𝑥
𝑎0 = 1 log 𝑎 1 = 0
𝑎1 = 𝑎 log 𝑎 𝑎 = 1
𝑎log𝑎 𝑥 = 𝑥
log 𝑎 𝑎 𝑥 = 𝑥
log 𝑎 𝑚 = log 𝑎 𝑛 iff 𝑚 = 𝑛

So, when evaluating logarithms all that we’re really asking is

what exponent did we put onto the base to get the number in the
logarithm. Now, before we get into some of the properties of
logarithms let’s first do a couple of quick graphs.

13
Example 4
Sketch the graph of the common logarithm and the natural loga-
rithm on the same axis system.
Solution
This example has two points. First, it will familiarize us with
the graphs of the two logarithms that we are most likely to see
in other classes. Also, it will give us some practice using our
calculator to evaluate these logarithms because the reality is
that is how we will need to do most of these evaluations.
Here is a table of values for the two logarithms.
Here is a table of values for the two logarithms.
𝑥 𝑓(𝑥) = 𝑙𝑜𝑔(𝑥) 𝑔(𝑥) = 𝐼𝑛(𝑥)
1 -0.3010 -0.6931
2
1 0 0
2 0.3010 0.6931
3 0.4771 1.0986
4 0.6021 1.3863
Here is a sketch of the graphs of these two functions.
Chart Title
1.5

0.5

0
1 2 3 4 5
-0.5

-1

f(x)=log(x) g(x)=in(x)

1.2.2 Common Logarithm Mistakes

This are common mistakes that people made when they are dealing
with logs and exponentials:
𝐥𝐨𝐠 𝒂 𝒙 + 𝐥𝐨𝐠 𝒂 𝒚 ≠ 𝐥𝐨𝐠 𝒂 (𝒙 + 𝒚)

14
Example

log(2 + 8) ≠ log 2 + log 8

1 ≠ 0.3010 +0.9031
1 ≠ 1.2041

𝐥𝐨𝐠 𝒂 𝒙 − 𝐥𝐨𝐠 𝒂 𝒚 ≠ 𝐥𝐨𝐠 𝒂 (𝒙 − 𝒚)

Example 5

log(120 − 20) ≠ log 120 − log 20

2 ≠ 2.0792 − 1.3010
1 ≠ 0.7782
𝒙 𝐥𝐨𝐠 𝒂 𝒙
𝐥𝐨𝐠 𝒂 ( ) ≠
𝒚 𝐥𝐨𝐠 𝒂 𝒚

Example 6

1 log 𝑎 1
log 𝑎 ( )≠
10 log 𝑎 10
0
-1 ≠
1

(𝐥𝐨𝐠 𝒂 𝒙)𝒚 ≠ 𝒚 𝐥𝐨𝐠 𝒂 𝒙

Example 7

(log10 100)3 ≠ 3 log10 100

(2)3 ≠ 3(2)
8≠6

15
Example 8: Express as a single logarithm. Simplify if possible

a) 𝐥𝐨𝐠 𝟗 𝟑 + 𝐥𝐨𝐠 𝟗 𝟐𝟒𝟑

Solution

Let x = log 9 3 + log 9 243

= log 9 (3 × 243) = log 9 (3243) = log 9 (729) = log 9 (93 ) = 3 log 9 (9) =

3(1) ∴= 3

b) 𝐥𝐨𝐠 𝟐 𝟗𝟔 − 𝐥𝐨𝐠 𝟐 𝟔

Solution

log 2 96 − log 2 6

96
= log 2 ( ) = log 2 (16) = log 2 (24 )
6

= 4 log 2 (2) ∴= 4

c) 𝐥𝐨𝐠 𝟖 + 𝐥𝐨𝐠 𝟐𝟓 − 𝐥𝐨𝐠 𝟐

SOLUTION

log 8 + log 25 − log 2

8 × 25
= log ( )
2

= log(100)

=2

16
 d) 𝐥𝐨𝐠 𝒙 + 𝐥𝐨𝐠 √𝒚 − 𝟑 𝐥𝐨𝐠 𝒛

SOLUTION

log 𝑥 + log √𝑦 − 3 log 𝑧

1
1 𝑥𝑦 2
= log 𝑥 + log 𝑦 − log 𝑧 3 = log ( 3 )
2
𝑧

𝟑
e) 𝐥𝐨𝐠 √𝒙 − 𝐥𝐨𝐠 𝒚𝟑 + 𝟐(𝐥𝐨𝐠 𝒚 + 𝐥𝐨𝐠 𝒙𝟐 )

SOLUTION

1
= log 𝑥 3 − log 𝑦 3 + 2 log 𝑦 + 2log 𝑥 2
1
= log 𝑥 3 − log 𝑦 3 + log 𝑦 2 + log 𝑥 2×2
1
13
(𝑥 3 )(𝑦 2 )(𝑥 4 ) 𝑥3
= log ( ) = log ( )
𝑦3 𝑦

f) 𝐥𝐨𝐠 𝒂 (𝒙𝟐 − 𝟓𝒙 + 𝟔) − 𝐥𝐨𝐠 𝒂 (𝒙 − 𝟑)

SOLUTION

log 𝑎 (𝑥 2 − 5𝑥 + 6) − log 𝑎 (𝑥 − 3)

𝑥 2 − 5𝑥 + 6
= log 𝑎 ( )
𝑥−3

(𝑥 − 3)(𝑥 − 2)
= log 𝑎 ( ) = log 𝑎 (𝑥 − 2)
𝑥−3

17
 1.2.3. Exponential Growth/Decay.

Many quantities in the world can be modeled (at least for a short
time) by the exponential growth/decay equation.

𝑄 = 𝑄0 𝑒 𝑘𝑡 ,

where 𝑄0 constant. If 𝑘 is positive we will get exponential growth

constant and if 𝑘 is negative we will get exponential decay con-
stant.

Example 9
A population of bacteria initially has 250 present and in 5 days
there will be 1600 bacteria present.

1. Determine the exponential growth constant for this population.

𝑄 = 𝑄0 𝑒 𝑘𝑡
Data: 𝑄0 = 250 , 𝑄(5) = 1600 𝑎𝑛𝑑 𝑡 = 5
1600 = 250𝑒 5𝑘
1600
= 𝑒 5𝑘
250
1600
ln ( ) = 5𝑘𝑙𝑛𝑒
250
1600
ln ( )
250 = 𝑘
5
𝑘 = 0.3712596
2.How long will it take for the population to grow from its ini-
tial population of 250 to a population of 2000?
𝑄 = 𝑄0 𝑒 𝑘𝑡
Data: 𝑄0 = 250 , 𝑄(5) = 2000 𝑎𝑛𝑑 𝑡 =?
2000 = 250𝑒 0.3713𝑡
1600
= 𝑒 0.3713𝑡
250
1600
ln ( ) = 𝑙𝑛(𝑒 0.3713𝑡 )
250
1600
ln ( ) = 0.3713𝑡
250
1600
ln ( )
𝑡= 250
0.3713
𝑡 = 4.9995

18
 Example 10
We initially have 100 grams of a radioactive element and in 1250
years there will be 80 grams left.

1. Determine the exponential decay equation for this element.

𝑄(0) = 100 𝑎𝑛𝑑 𝑄(1250) = 80

80 = 100𝑒 1250𝑘

4
ln ( ) = 1250𝑘
5
𝑘 = −0.00017852

2. How long will it take for half of the element to decay?

𝑄(𝑡) = 50 = 100𝑒 −0.000179𝑡

1
= 𝑒 −0.000179𝑡
2
1
ln ( ) = −0.00179𝑡
2
1
ln ( )
𝑡= 2 = 3882.855
0.000179

3. How long will it take until there is only 1 gram of the element
1 4
ln ( )𝑡
left? 𝑄(𝑡) = 100𝑒 1250 5

1 1 4
ln ( )𝑡
= 𝑒 1250 5
100
1 1 4
ln ( )= 𝑙𝑛 ( ) 𝑡
100 1250 5
1
1250𝑙𝑛 (
𝑡= 100)
4
𝑙𝑛 ( )
5
𝑡 = 25797.128

19
TUTORIAL 1 CONTINUATION FROM PAGE 9 and 10

9.Change the exponential statement to an equivalent statement using loga-

rithms.

1 𝑥
a) (4) = 6
b) 10𝑚 = 7
c) 𝑒 2𝑡 = 5

10. Change the logarithmic statement to an equivalent statement using expo-

nents.

a) log 3 5 = 𝑥
1
b) log 𝑥 = 2
c) log 2 (𝑦 + 1) = −3

11.Find the exact value of each logarithmic expression without using a cal-
culator.

1
a) log 3 9
1
b) log 4 64
1
c) ln (𝑒)
1
d) log 10000
e) log 1000
f) log 4 1
g) log 6 6√6

12.Solve for x

a) 12−4𝑒 7+3𝑥 =7
b) 1=10−3𝑒 2−2𝑧
c) 2t−t𝑒 6𝑡−1 =0
2
d) 4𝑥 + 1 = (12𝑥 + 3)𝑒 𝑥 −2
e) 2𝑒 3𝑦−8 − 11𝑒 5−10𝑦 = 0
2𝑥−1
f) 1 − 8𝑙𝑛( 7 ) = 14
g) ln(y−1)=1+ln(3y+2)
h) ln 10 − ln(7 − 𝑥) = ln (𝑥)
i) log 2 (𝑥 2 − 6𝑥) = 3 + log 2 (1 − 𝑥)

20
13.The growth of a colony of bacteria is given by the equation,

𝑄(𝑡) = 𝑄0 𝑒 0.195𝑡

If there are initially 500 bacteria present and t is given in hours deter-
mine each of the following.

(a) How many bacteria are there after a half of a day?

(b) How long will it take before there are 10000 bacteria in the colony?

21
CHAPTER 2: Arithmetic and Geometric Progressions

This unit introduces sequences and series and gives some simple
examples of each. It also explores types of sequence known as
arithmetic progressions (APs) and geometric progressions (GPs),
and the corresponding series. In order to master the techniques
explained here it is vital that you undertake plenty of practice
exercises so that they become second nature. After reading this
text, and/or do exercise/tutorial on this topic, you should be
able to:
➢ Recognise the difference between a sequence and a series;
➢ Recognise an arithmetic progression;
➢ Find the 𝑛-th term of an arithmetic progression;
➢ Find the sum of an arithmetic series;
➢ Recognise a geometric progression;
➢ Find the 𝑛-th term of a geometric progression;
➢ Find the sum of a geometric series;
➢ Find the sum to infinity of a geometric series with common
ratio |𝑟| < 1.

2.1. Sequences
What is a sequence? It is a set of numbers which are written in
some order. For example, take the numbers

1, 3, 5, 7, 9, . . ..

Here, we seem to have a rule. We have a sequence of odd numbers.

To put this another way, we start with the number 1, which is an
odd number, and then each successive number is obtained by add-
ing 2 to give the next odd number. Here is another sequence:
1, 4, 9, 16, 25, . . ..

22
This is the sequence of square numbers. And this sequence,

1, −1, 1, −1, 1, −1, . . .,

is a sequence of numbers alternating between 1 and −1. In each

case, the dots written at the end indicate that we must consider
the sequence as an infinite sequence, so that it goes on for
ever. On the other hand, we can also have finite sequences. The
numbers

1, 3, 5, 9

form a finite sequence containing just four numbers. The numbers

1, 4, 9, 16

also form a finite sequence. And so, do these, the numbers

1, 2, 3, 4, 5, 6, . . . , 𝑛 .

These are the numbers we use for counting, and we have included
𝑛 of them. Here, the dots indicate that we have not written all
the numbers down explicitly. The 𝑛 after the dots tells us that
this is a finite sequence, and that the last number is 𝑛. Here
is a sequence that you might recognise:

1, 1, 2, 3, 5, 8, . . ..

This is an infinite sequence where each term (from the third

term onwards) is obtained by adding together the two previous
terms. This is called the Fibonacci sequence. We often use an
algebraic notation for sequences. We might call the first term
in a sequence 𝑢1 , the second term 𝑢2 , and so on. With this same
23
notation, we would write 𝑢𝑛 to represent the 𝑛-th term in the
sequence. So
𝑢1 , 𝑢2 , 𝑢3 , . . . , 𝑢𝑛

would represent a finite sequence containing n terms. As another

example, we could use this notation to represent the rule for
the Fibonacci sequence. We would write
𝑢𝑛 = 𝑢𝑛−1 + 𝑢𝑛−2

to say that each term was the sum of the two preceding terms.

Key Point

A sequence is a set of numbers written in an order. We sometimes

write 𝑢1 for the first term of the sequence, 𝑢2 for the second
term, and so on. We write the 𝑛-th term as 𝑢𝑛 .

Exercise 1

a) A sequence is given by the formula 𝑢𝑛 = 3𝑛 + 5, for 𝑛 =

1, 2, 3, . . .. Write down the first five terms of this se-
quence.
1
b) A sequence is given by 𝑢𝑛 = 2, for 𝑛 = 1, 2, 3, . . ..
𝑛
Write down the first four terms of this sequence. What is
the 10th term?
c) Write down the first eight terms of the Fibonacci se-
quence defined by 𝑢𝑛 = 𝑢𝑛−1 + 𝑢𝑛−2 , when 𝑢1 = 1, and
𝑢2 = 1.
d) Write down the first five terms of the sequence given by
(−1)𝑛+1
𝑢𝑛 =
𝑛

24
2.2. Series
A series is something we obtain from a sequence by adding all
the terms together. For example, suppose we have the sequence

𝑢1 , 𝑢2 , 𝑢3 . . . , 𝑢𝑛 .

The series we obtain from this is

𝑢1 + 𝑢2 + 𝑢3 +. . . + 𝑢𝑛 ,

and we write 𝑆𝑛 for the sum of these 𝑛 terms. So, although the
ideas of a ‘sequence’ and a ‘series’ are related, there is
an important distinction between them. For example, let us con-
sider the sequence of numbers
1, 2, 3, 4, 5, 6, . . . , 𝑛 .

Then 𝑆1 = 1, as it is the sum of just the first term on its own.

The sum of the first two terms is 𝑆2 = 1 + 2 = 3. Continuing,
we get

𝑆3 = 1 + 2 + 3 = 6 ,
𝑆4 = 1 + 2 + 3 + 4 = 10 ,
and so on.

Key Point

A series is a sum of the terms in a sequence. If there are 𝑛

terms in the sequence and we evaluate the sum then we often
write 𝑆𝑛 for the result, so that.
𝑆𝑛 = 𝑢1 + 𝑢2 + 𝑢3 +. . . + 𝑢𝑛

Exercise 2

Write down 𝑆1 , 𝑆2 , . . . , Sn for the sequences

25
 a) 1, 3, 5, 7, 9, 11;
b) 4, 2, 0,−2,−4.

2.3. Arithmetic Progressions

Consider these two common sequences

1, 3, 5, 7, . ..
and
0, 10, 20, 30, 40, . ..

It is easy to see how these sequences are formed. They each

start with a first term, and then to get successive terms we
just add a fixed value to the previous term. In the first se-
quence we add 2 to get the next term, and in the second sequence
we add 10. So, the difference between consecutive terms in each
sequence is a constant. We could also subtract a constant in-
stead, because that is just the same as adding a negative con-
stant. For example, in the sequence

8, 5, 2, −1, −4, . ..

the difference between consecutive terms is −3. Any sequence

with this property is called an arithmetic progression, or AP
for short.

We can use algebraic notation to represent an arithmetic pro-

gression. We shall let 𝑎 stand for the first term of the se-
quence and let 𝑑 stand for the common difference between succes-
sive terms. For example, our first sequence could be written as

1, 3, 5, 7, 9, . ..
1, 1 + 2, 1 + 2 × 2, 1 + 3 × 2, 1 + 4 × 2, . . .,

and this can be written as

𝑎, 𝑎 + 𝑑, 𝑎 + 2𝑑, 𝑎 + 3𝑑, 𝑎 + 4𝑑, . ..

26
where 𝑎 = 1 is the first term, and 𝑑 = 2 is the common differ-
ence. If we wanted to write down the 𝑛-th term, we would have

𝑎 + (𝑛 − 1)𝑑 ,

because if there are 𝑛 terms in the sequence there must be (𝑛 −

1) common differences between successive terms, so that we must
add on (𝑛 − 1)𝑑 to the starting value 𝑎. We also sometimes
write ℓ for the last term of a finite sequence, and so in this
case we would have

ℓ = 𝑎 + (𝑛 − 1)𝑑.

Key Point
An arithmetic progression, or AP, is a sequence where each new
term after the first is obtained by adding a constant 𝑑,
called the common difference, to the preceding term. If the
first term of the sequence is 𝑎 then the arithmetic progression
is
𝑎, 𝑎 + 𝑑, 𝑎 + 2𝑑, 𝑎 + 3𝑑, . ..

where the 𝑛-th term is 𝑎 + (𝑛 − 1)𝑑.

Exercise 3

a) Write down the first five terms of the AP with first term
8 and common difference 7.
b) Write down the first five terms of the AP with first term
2 and common difference 5.
c) What is the common difference of the AP 11, −1, −13, −25, .. ?
d) Find the 17th term of the arithmetic progression with
first term 5 and common difference 2.
e) Write down the 10th and 19th terms of the APs

27
 i) 8, 11, 14, . . .,
ii) ii) 8, 5, 2 . ...
f) An AP is given by k, 2k/3, k/3, 0, . . ..
(i) Find the sixth term.
(ii) Find the 𝑛th term.
(iii) If the 20th term is equal to 15, find k.

2.3.1. The sum of an arithmetic

series
Sometimes we want to add the terms of a sequence. What would we
get if we wanted to add the first 𝑛 terms of an arithmetic pro-
gression? We would get

𝑆𝑛 = 𝑎 + (𝑎 + 𝑑) + (𝑎 + 2𝑑) + . . . + (ℓ − 2𝑑) + (ℓ − 𝑑) + ℓ.

Now this is now a series, as we have added together the 𝑛 terms

of a sequence. This is an arithmetic series, and we can find its
sum by using a trick. Let us write the series down again, but
this time we shall write it down with the terms in reverse or-
der. We get

𝑆𝑛 = ℓ + (ℓ − 𝑑) + (ℓ − 2𝑑) + . . . + (𝑎 + 2𝑑) + (𝑎 + 𝑑) + 𝑎.

We are now going to add these two series together. On the left-
hand side, we just get 2𝑆𝑛. But on the right-hand side, we are
going to add the terms in the two series so that each term in
the first series will be added to the term vertically below it
in the second series. We get

2𝑆𝑛 = (𝑎 + ℓ) + (𝑎 + ℓ) + (𝑎 + ℓ) + . . . + (𝑎 + ℓ) + + (𝑎 + ℓ) ,

and on the right-hand side there are 𝑛 copies of (𝑎 + ℓ) so we

get
2𝑆𝑛 = 𝑛(𝑎 + ℓ) .

28
But of course, we want 𝑆𝑛 rather than 2𝑆𝑛, and so we divide by 2
to get

1
𝑆𝑛 = 𝑛(𝑎 + ℓ) .
2

We have found the sum of an

arithmetic progression in terms of
its first and last terms, 𝑎
and ℓ, and the number of terms 𝑛. We
can also find an expression
for the sum in terms of the 𝑎, 𝑛 and
the common difference 𝑑. To
do this, we just substitute our for-
mula for ℓ into our formula
for 𝑆𝑛. From
1
ℓ = 𝑎 + (𝑛 − 1)𝑑 , 𝑆𝑛 = 𝑛(𝑎 + ℓ)
2
we obtain
1
𝑆𝑛 = 𝑛[𝑎 + 𝑎 + (𝑛 − 1)𝑑]
2
1
𝑆𝑛 = 𝑛[2𝑎 + (𝑛 − 1)𝑑]
2

Key Point

The sum of the terms of an arithmetic progression gives an

arithmetic series. If the starting value is 𝑎 and the common
difference is 𝑑 then the sum of the first 𝑛 terms is

1
𝑆𝑛 = 𝑛[2𝑎 + (𝑛 − 1)𝑑].
2

If we know the value of the last term ℓ instead of the common

difference, 𝑑 then we can write the sum as
1
𝑆𝑛 = 𝑛(𝑎 + ℓ)
2

Example

Find the sum of the first 50 terms of the sequence

1, 3, 5, 7, 9, . . . .

29
Solution

This is an arithmetic progression, and we can write down

𝑎 = 1 , 𝑑 = 2 , 𝑛 = 50 .
We now use the formula, so that
1
𝑆𝑛 = 𝑛[2𝑎 + (𝑛 − 1)𝑑]
2
1
𝑆50 = × 50 × (2 × 1 + (50 − 1) × 2)
2
= 25 × (2 + 49 × 2)
= 25 × (2 + 98)
= 2500.

Example

Find the sum of the series

1 + 3・5 + 6 + 8・5 + . . . + 101 .

Solution
This is an arithmetic series, because the difference between the
terms is a constant value, 2.5. We also know that the first term
is 1, and the last term is 101. But we do not know how many
terms are in the series. So, we will need to use the formula for
the last term of an arithmetic
progression,
ℓ = 𝑎 + (𝑛 − 1)𝑑
to give us
101 = 1 + (n − 1) × 2.5.
Now this is just an equation for 𝑛, the number of terms in the
series, and we can solve it. If we subtract 1 from each side, we
get
100 = (n − 1) × 2.5
and then dividing both sides by 2.5 gives us
40 = n − 1
so that n = 41. Now we can use the formula for the sum of an
arithmetic progression, in the version using ℓ, to give us
1
𝑆𝑛 = 𝑛(𝑎 + ℓ)
2

30
 1
𝑆41 = 41(1 + 101)
2
= 2091.

Example

An arithmetic progression has 3 as its first term. Also, the sum

of the first 8 terms is twice the sum of the first 5 terms. Find
the common difference.

Solution
We are given that 𝑎 = 3. We are also given some information
about the sums 𝑆8 and 𝑆5 , and we want to find the common differ-
ence. So, we shall use the formula
1
𝑆𝑛 = 𝑛(2𝑎 + (𝑛 − 1)𝑑)
2
for the sum of the first n terms. This tells us that
1
𝑆8 = (8)(2(3) + (8 − 1)𝑑)
2
and that
1
𝑆5 = (5)(2(3) + (5 − 1)𝑑)
2
So, using the given fact that 𝑆8 = 2𝑆5 , we see that
1 1
× 8 × (6 + 7𝑑) = 2 × × 5 × (6 + 4𝑑)
2 2
4 × (6 + 7𝑑) = 5 × (6 + 4𝑑)
24 + 28𝑑 = 30 + 20𝑑
8𝑑 = 6
𝑑 = ¾

Exercise 4

a) Find the sum of the first 23 terms of the AP 4, −3, −10, . . ..

b) An arithmetic series has first term 4 and common differ-
1
ence . Find
2
(i) the sum of the first 20 terms,
(ii) the sum of the first 100 terms.
c) Find the sum of the arithmetic series with first term 1,
common difference 3, and last term 100.

31
 d) The sum of the first 20 terms of an arithmetic series is
identical to the sum of the first 22 terms. If the common
difference is −2, find the first term.

2.4. Geometric Progressions

We shall now move on to the other type of sequence we want to
explore. Consider the sequence

2, 6, 18, 54, . . ..

Here, each term in the sequence is 3 times the previous term.

And in the sequence

1, −2, 4, −8, . . .,

each term is −2 times the previous term. Sequences such as

these are called geometric progressions, or GPs for short.

Let us write down a general geometric progression, using alge-

bra. We shall take 𝑎 to be the first term, as we did with arith-
metic progressions. But here, there is no common difference. In-
stead there is a common ratio, as the ratio of successive terms
is always constant. So, we shall let 𝑟 be this common ratio.
With this notation, the general geometric progression can be ex-
pressed as

𝑎, 𝑎𝑟, 𝑎𝑟 2 , 𝑎𝑟 3 , . . ..

So, the 𝑛-th can be calculated quite easily. It is 𝑎𝑟 𝑛−1 , where

the power (𝑛 − 1) is always one less than the position 𝑛 of the
term in the sequence. In our first example, we had 𝑎 = 2 and
𝑟 = 3, so we could write the first sequence as

2, 2 × 3, 2 × 32 , 2 × 33 , . . ..

32
In our second example, 𝑎 = 1 and 𝑟 = −2, so that we could write
it as

1, 1 × (−2), 1 × (−2)2 , 1 × (−2)3 , . . ..

Key Point
A geometric progression, or GP, is a sequence where each new
term after the first is obtained by multiplying the preceding
term by a constant 𝑟, called the common ratio. If the first
term of the sequence is 𝑎 then the geometric progression is
𝑎, 𝑎𝑟, 𝑎𝑟 2 , 𝑎𝑟 3 , . . ..
where the 𝑛-th term is 𝑎𝑟 𝑛−1 .

Exercise 5

a) Write down the first five terms of the geometric progres-

1
sion which has first term 1 and common ratio .
2
b) Find the 10th and 20th terms of the GP with first term 3
and common ratio 2.
c) Find the 7th term of the GP 2, −6, 18, .. .,

2.4.1. The sum of a geometric series

Suppose that we want to find the sum of the first 𝑛 terms of a
geometric progression. What we get is

𝑆𝑛 = 𝑎 + 𝑎𝑟 + 𝑎𝑟 2 + 𝑎𝑟 3 + . . . + 𝑎𝑟 𝑛−1

and this is called a geometric series. Now the trick here to

find the sum is to multiply by r and then subtract:

𝑆𝑛 = 𝑎 + 𝑎𝑟 + 𝑎𝑟 2 + 𝑎𝑟 3 + . . . + 𝑎𝑟 𝑛−1
𝑟𝑆𝑛 = 𝑎𝑟 + 𝑎𝑟 2 + 𝑎𝑟 3 + . . . + 𝑎𝑟 𝑛−1 + 𝑎𝑟 𝑛

33
 𝑆𝑛 = 𝑎 + 𝑎𝑟 + 𝑎𝑟 2 + 𝑎𝑟 3 + . . . + 𝑎𝑟 𝑛−1
𝑆𝑛 − 𝑟𝑆𝑛 = 𝑎 − 𝑎𝑟 𝑛

so that
𝑆𝑛 (1 − 𝑟) = 𝑎 (1 − 𝑟 𝑛 ).

Now divide by 1 − 𝑟 (if 𝑟 ≠ 1) to give

𝑎 (1−𝑟 𝑛 )
𝑆𝑛 = .
(1−𝑟)

Key Point
The sum of the terms of a geometric progression gives a geo-
metric series. If the starting value is 𝑎 and the common ratio
is 𝑟 then the sum of the first 𝑛 terms is

𝑎 (1 − 𝑟 𝑛 )
𝑆𝑛 =
(1 − 𝑟)
provided that 𝑟 ≠ 1.

Example

Find the sum of the geometric series

2 + 6 + 18 + 54 + . . .

where there are 6 terms in the series.

Solution

For this series, we have 𝑎 = 2, 𝑟 = 3 and 𝑛 = 6. So

𝑎 (1 − 𝑟 𝑛 )
𝑆𝑛 =
(1 − 𝑟)

34
 2 (1 − 36 )
𝑆6 =
(1 − 3)
𝑆6 = 728

Example

Find the sum of the geometric series

8 − 4 + 2 − 1 + . . .

where there are 5 terms in the series.

Solution

1
For this series, we have a = 8, r = and n = 5. So
2

1 5
8(1 − ( ) ) 1
𝑆5 = 2 =5
1 2
(1 − )
2

Example
How many terms are there in the geometric progression?

2, 4, 8, . . . , 128 ?

Solution

In this sequence a = 2 and r = 2. We also know that the 𝑛-th

term is 128. But the formula for the n-th term is 𝑎𝑟 𝑛−1 . So

128 = 2 × 2𝑛−1

35
64 = 2𝑛−1
26 = 2𝑛−1
6=𝑛−1
𝑛=7

So there are 7 terms in this geometric progression.

Exercise 6

a) Find the sum of the first five terms of the GP with first
term 3 and common ratio 2.
b) Find the sum of the first 20 terms of the GP with first
term 3 and common ratio 1.5.
37
c) The sum of the first 3 terms of a geometric series is .
8
3367
The sum of the first six terms is . Find the first term
512
and common ratio.
d) How many terms in the GP 4, 3.6, 3.24, . . . are needed so
that the sum exceeds 35?

2.4.2. Convergence of geometric series

Consider the geometric progression

1 1 1 1
1, , , , , ….
2 4 8 16
1
We have 𝑎 = 1 and 𝑟 = , and so we can calculate some sums. We
2
get

𝑆1 = 1
1 3
𝑆2 = 1 + =
2 2
1 1 7
𝑆3 = 1 + + =
2 4 4

36
 1 1 1 15
𝑆4 = 1 + + + =
2 4 8 8

⋮
and there seems to be a pattern because

1=2−1
3 1
=2−
2 2
7 1
=2−
4 4
15 1
=2−
8 8

In each case, we subtract a small quantity from 2, and as we

take successive sums the quantity gets smaller and smaller. If
we were able to add ‘infinitely many’ terms, then the answer
‘ought to be’ 2 — or as near as we want to get to 2.

Let us see if we can explain this by using some algebra. We know

that

𝑎 (1 − 𝑟 𝑛 )
𝑆𝑛 =
1 − 𝑟
and we want to examine this formula in the case of our particu-
1
lar example where 𝑟 = . Now the formula contains the term 𝑟 𝑛
2
and, as −1 < 𝑟 < 1, this term will get closer and closer to
zero as 𝑛 gets larger and larger. So, if −1 < 𝑟 < 1, we can say
that the ‘sum to infinity’ of a geometric series is

𝑎
𝑆∞ =
1 − 𝑟

where we have omitted the term 𝑟 𝑛 . We say that this is the limit
of the sums 𝑆𝑛 as 𝑛 ‘tends to infinity’. You will find more
details of this concept in another unit.
37
Example

Find the sum to infinity of the geometric progression

1 1 1
1, , , ,…
3 9 27

Solution

1
For this geometric progression we have 𝑎 = 1 and 𝑟 = As
3
−1 < 𝑟 < 1 we can use the formula, so that

1 3
𝑆∞ = =
1 2
1 −
3

Key Point
The sum to infinity of a geometric progression with starting
value 𝑎 and common ratio 𝑟 is given by
𝑎
𝑆∞ =
1 − 𝑟
where −1 < 𝑟 < 1

Exercise 7

a) Find the sum to infinity of the GP with first term 3 and

1
common ratio .
3
b) The sum to infinity of a GP is four times the first term.
Find the common ratio.
c) The sum to infinity of a GP is twice the sum of the first
two terms. Find possible values of the common ratio.

38
Answers

1.
a) 8, 11, 14, 17, 20
1 1 1 1
b) 1, , , ; 10th term is
4 9 16 100
c) 1, 1, 2, 3, 5, 8, 13, 21
1 1 1 1
d) 1, − , , − ,
2 3 4 5

2.
a) 1, 4, 9, 16, 25, 36
b) 4, 6, 6, 4, 0

3.
a) 8, 15, 22, 29, 36
b) 2, -3, -8, -13, -18
c) -12
d) 37
e) (i) 35, 62 (ii) -19, -46
2𝑘 𝑘(4−𝑛) 45
f) (i) − (ii) (iii) −
3 3 16

4.
a) -1679
b) (i) 175 (ii) 2875
c) 1717
d) 41

5.
1 1 1 1
a) 1, , , ,
2 4 8 16
b) 1536, 1, 572, 864
c) 1458

6.
a) 93
b) 19 946
39
 3
c) 2,
4
d) 20 terms

7.
a) 6
3
b)
4
1
c) ±
√2

TUTORIAL 5a
1) In the year 2000 a shop sold 150 computers. Each year the
shop sold 10 more computers than the year before, so that
the shop sold 160 computers in 2001, 170 computers in 2002,
and so on forming an arithmetic sequence.

a) Show that the shop sold 220 computers in 2007

b) Calculate the total number of computers the shop sold
from 2000 to 2013 inclusive

In the year 2000, the selling price of each computer was

R900. The selling price fell by R20 each year, so that in
2001 the selling price was R880, in 2002 the selling price
was R860 and so on forming an arithmetic sequence.

c) In a particular year, the selling price of each com-

puter is Rs was equal to three times the number of

40
 computers the shop sold in that year. By forming and
solving an equation, find the year in which this oc-
curred.

2) A company, which is making 200 mobile phones each week,

plans to increase its production. The number of mobile
phones produced is to increase by 20 each week from 200 in
week 1 to 220 in week 2, to 240 in week 3 and so on, until
it is producing 600 in week 𝑁.

a) Find the value of 𝑁.

The company then plans to continue to make 600 mobile

phones each week.

b) Fin the total number of mobile phones that will be made

in the first 52 week starting from and including week 1.

3) Lewis played a game of space invaders. He scored points for

each spaceship that he captured. Lewis scored 140 points
for capturing his first spaceship. He scored 160 points for
capturing his second spaceship, 180 points for capturing
his third spaceship, and so on. The number of points scored
for capturing each successive spaceship formed an arithme-
tic sequence.

41
 a) Find the number of points that Lewis scored for captur-
ing his 20th spaceship.

b) Find the total number of points Lewis scored for captur-

ing his first 20 spaceship.

4) Sian played an adventure game. She scored points for each

dragon that she captured. The number of points that Sian
scored for capturing each successive dragon formed an
arithmetic sequence. Sian captured 𝑛 dragons and the total
number of points that she scored for capturing all 𝑛 drag-
ons was 8500. Given that Sian scored 300 points for captur-
ing first dragon and then 700 points for capturing her nth
dragon.

a) Find the value of 𝑛.

5) A sequence 𝑢1 , 𝑢2 , 𝑢3 , ⋯ is defined by
𝑢1 = 7 and 𝑢𝑛+1 = 𝑢𝑛 + 4 for 𝑛 ≥ 1
(i) Show that 𝑢17 = 71
(ii) Show that
35 50

∑ 𝑢𝑛 = ∑ 𝑢𝑛
𝑛=1 𝑛=36

6) A sequence 𝑢1 , 𝑢2 , 𝑢3 , ⋯ is defined by

42
 2
𝑢1 = 4 and 𝑢𝑛+1 = for 𝑛 ≥ 1
𝑢𝑛

(i) Write down the values of 𝑢2 and 𝑢3

(ii) Describe the behavior of the sequence.

7) In an arithmetic progression the ninth term is 18 and the

sum of the first nine term is 72. Find the first term and
common difference.

8) Calculate the sum of all the even numbers from 2 to 100 in-
clusive,
2 + 4 + 6 + ⋯ + 100
b) In the arithmetic series
𝑘 + 2𝑘 + 3𝑘 + ⋯ + 100
𝑘 is a positive integer and 𝑘 is a factor of 100

(i) Find, in terms of k, an expression for the number

of terms in this series.

(ii) Show that the sum of this series is

5000
50 +
𝑘

c) Find, in terms of k, the 50th term of the arithmetic se-

quence
(2𝑘 + 1), (4𝑘 + 4), (6𝑘 + 7), … .,

43
 giving your answer in its simplest form.

9) Jill gave money to a charity over a 20-year period, from Year

1to Year 20 inclusive. She gave R150 in Year 1, R160 in Year
2, R170 in Year 3, and so on, so that the amounts of the
money she gave each year formed an arithmetic sequence.

a) Find the amount of money she gave in Year 10.

b) Calculate the total amount of money she gave over the 20-
year period

Kevin also gave money to charity over the same 20-year period. He
gave R𝑋 in year 1 and the amounts of the money he gave each year
increased, forming an arithmetic sequence with common difference
R30. The total amount of money that Kevin gave over the 20-year
period was twice the total amount of money that Jill gave.

c) Calculate the value of 𝑋.

10) A 40-year building programme for new house began in

oldtown in the year 1951 (Year 1) and finished in 1990 (Year
40). The numbers of houses built each year form an arithmetic
sequence with first term 𝑎 and common difference 𝑑. Given

44
 that 2400 new houses were built in 1960 and 600 new houses
were built in 1990, find

(a) The value of 𝑑

(b) The value of 𝑎

(c) The total number of houses built in oldtown over the

40-year period.

11) The first term of an arithmetic sequence is 30 and the

common difference is -1.5

(a) Find the value of the 25th term

The 𝑟th term of the sequence is 0

(b) Find the value of 𝑟

The sum of the 𝑛 terms of the sequence is 𝑆𝑛 .

(c) Find the largest positive value of 𝑆𝑛 .

TUTORIAL 5b

45
1) a) In an arithmetic progression the sum of the first ten
terms is 400 and the sum of the next ten terms is 1000. Find the
common difference and the first term.
b) A geometric progression has first term 𝑎, common ratio 𝑟 and
sum to infinity 6. The second geometric progression has the
first term 2𝑎, common ration 𝑟 2 and sum to infinity 7. Find the
values of 𝑎 and 𝑟.

2) The third term of a geometric progression is -108 and the

sixth term is 32. Find
a) The common ratio
b) The first term
c) The sum to infinity
3) A company predicts a yearly of R120 000 in the year 2013.
The company predicts that the profit rise each by 5%. The pre-
dicted yearly profit forms a geometric sequence with common
ratio 1.05
a) Show that the predicted profit in the year 2016 is R138 915
b) Find the first year in which the yearly predicted profit
exceeds R200 000
c) Find the total predicted profit for the years 2013 to 2023
inclusive, giving your answer to the nearest rand.

4) (i) The first three terms of an arithmetic progression are

2𝑥, 𝑥 + 4 𝑎𝑛𝑑 2𝑥 − 7 respectively. Find the value of 𝑥.
(ii) The first three terms of another sequence are also 2𝑥, x+4
and 2x-7 respectively
a) Verify that when 𝑥 = 8 the terms from a geometric progres-
sion and the sum to infinity in this case.

46
 b) Find the other possible value of x that also gives a geo-
metric progression.

5) A geometric series is 𝑎 + 𝑎𝑟 + 𝑎𝑟 2 + ⋯
a) Prove that the sum of the first 𝑛 terms of this series is
given by
𝑎(1 − 𝑟 𝑛 )
𝑆𝑛 =
1−𝑟
The third and fifth terms of a geometric series are 5.4 and
1.944 respectively and all the terms in the series are positive.
For this series, find
b) The common ratio,
c) The first term,
d) The sum to infinity

6) (a) An arithmetic progression has first term log 2 27 and common

difference log 2 𝑥.
(i) Show that the fourth term can be written as log 2 (27 𝑥 3 ).
(ii) Given that the fourth term is 6, find the exact value
of 𝑥.

(b) A geometric progression has first term log 2 27 and common

ration log 2 𝑦.
(i) Find the set of values of 𝑦 for which the geometric pro-
gression has a sum to infinity.
(ii) Find the exact value of 𝑦 for which the sum to infinity
of the geometric progression is 3.

7) A geometric series has first term 𝑎 = 360 and common ratio

47
 7
𝑟= .
8

Given your answer to 3 significant figures where appropriate, find

(a) The 20th term of the series
(b) The sum of the first 20 terms of the series
(c) The sum to infinity of the series

8) The second and third terms of a geometric series are 192 and
144 respectively.
For this series, find
(a) The common ratio
(b) The first term
(c) The sum to infinity
(d) The smallest value of 𝑛 for which the sum of the first 𝑛
terms of the series exceeds 1000.
9) The second and fifth terms of a geometric series are 750 and
-6 respectively.
Find
(a) The common ratio
(b) The first term of the series
(c) The sum to infinity of the series
10) The third term of a geometric sequence is 324 and the sixth
term is 96.
2
(a) Show that the common ratio of the sequence is .
3
(b) Find the first term of the sequence.
(c) Find the sum of the first 15 terms of the sequence.
(d) Find the sum to infinity of the sequence.

11) The first three terms of a geometric series are (k+4), k and
(2k-15) respectively, where k is a positive constant.

48
(a) Show that 𝑘 2 − 7𝑘 − 60 = 0.
(b) Hence show that 𝑘 = 12
(c) Find the common ration of this series.
(d) Find the sum to infinity of this series

12) The forth term of a geometric series is 10 and the seventh

term of the series is 80.
For this series, find
(a) The common ratio
(b) The first term
(c) The sum of the first 20 terms, giving your answer to the
nearest whole number.
4
13) A geometric series has first term 5 and common ratio 𝑟 = .
5

Calculate
(a) The 20th term of the series, to 3 decimal places
(b) The sum to infinity of the series
Given that the sum to 𝑘 terms of the series is greater than 24.95
𝑙𝑜𝑔0.002
(c) Show that 𝑘 >
𝑙𝑜𝑔0.8
(d) Find smallest possible value of 𝑘.
14) A trading company made a profit of R50 000 in 2006(Year 1). A
model for the future trading predicts that profits will increase
year by year in a geometric sequence with common ratio 𝑟, 𝑟 > 1.
The model therefore predicts that in 2007 (Year 2) a profit of
R50 000r will be made.
(a) Write down an expression for the predicted profit in Year
n.
The model predicts that in Year n, the profit made will exceed
R200 000.

49
 𝑙𝑜𝑔4
(b) Show that 𝑛 > +1
log 𝑟

Using the model with 𝑟 = 1.09

(c) Find the year in which the profit will exceed R200 000.
(d) Find the total of the profits that will be made by the
company over the 10 years from 2006 to 2015 inclusive,
giving your answer to the nearest R10 000.
15. A geometric series is 𝑎 + 𝑎𝑟 + 𝑎𝑟 2 + ⋯

(a) Prove that the sum of the n terms of the series is

given by
(b) Find
10

∑ 100(2𝑘 )
𝑘=1

(c) Find the sum to infinity of the geometric series

5 5 5
+ + +⋯
6 18 58

50
CHAPTER 3: Elementary Interest
Calculations and Pricing

Learning Objectives:

After studying this chapter, you should be able to:

➢ Define the concept of interest and show how it relates to

the time value of money.
➢ Distinguish between simple and compound interest and demon-
strate how to calculate each.
➢ Distinguish between the nominal interest rate and the ef-
fective annual yield.
➢ Distinguish between the concepts of future value and pre-
sent value.
➢ Define the following terms: principal, maturity date, the
term of a loan, blended payment, amortization, and net pre-
sent value.

3.1. Interest
Definition: Interest is the money paid for the use of money
For example: if you borrow money from the bank to buy a car,
the bank will charge you interest for it use. If you open saving
account of the bank, the bank will pay you interest for as long
as the account it open
Types of interest
➢ Simple interest (SI), which is interest earned only the
original amount called principal, lent over period at cer-
tain rate.

51
 ➢ Compound interest (CI), earned interest that is periodical
added to the principal and thereafter itself earns interest
at the same rate

Interest rate terms

• Compounding period (CP) – the time between points when in-
terest is computed and related to the initial amount
• Payment period (PP) – the shortest time between payments.
Interest is earned on payment money once per period (cot of
money)
• Nominal rate (NR) is simplified expression of the annual
cost of money. It means nothing, unless the compounding pe-
riod is stated along with it.
• Annual percentage rate (APR) is the nominal interest rate
on yearly basis
• Effective rate (i) is the rate that used with the table
nominal rate considering both the compounding period and
the payment period so that the blocks match.
For compounding Interest:
✓ Annually means “once per year” (n=1)
✓ Semi-annually or half-yearly means “2 times per year”
(n=2)
✓ Quarterly means “4 times per year” (n=4)
✓ Monthly means “12 times per year” (n=12)
✓ Daily usually means “365 times per year”, or “366 times
per year” during a leap year.
Periodic rate (PR)
PR is found by dividing the annual rate (often called the nomi-
nal rate) by the number of compounding periods per year
𝑨𝒏𝒏𝒖𝒂𝒍 𝒓𝒂𝒕𝒆
𝑷𝑹 =
𝑷𝒆𝒓𝒊𝒐𝒅 𝒑𝒆𝒓 𝒚𝒆𝒂𝒓

52
Example:
Find the periodic rate for
a) 6% compounded semi-annually
b) 7.5% compounded quarterly
c) 8.25% compounded monthly

Solution
6%
a) = 3%
2
7.5%
b) = 1.875%
4
8.5%
c) = 0.6875%
12

TIP: Don’t make the common mistake of rounding off a periodic

rate (i.e. 0.6875 not equal to 0.69)

3.2. Nominal and Effective inter-

est rate
There are two common forms of interest rate:
✓ Nominal interest rate
✓ Effective periodic interest rate
Nominal and effective interest rates are common in business, fi-
nance, and engineering economy. Each type must be understood in
order to solve various problem where interest is stated in vari-
ous ways.

53
3.2.1. Nominal interest rate, r
Definition: A nominal interest rate (r) is an interest rate that
does not include any consideration of compounding / does not ac-
count for compounding. A nominal rate may be calculated for any
time period longer than the time period stated.
Mathematically,

𝒓 = (𝑰𝒏𝒕𝒆𝒓𝒆𝒔𝒕 𝒓𝒂𝒕𝒆 𝒑𝒆𝒓 𝒑𝒆𝒓𝒊𝒐𝒅)(𝒏𝒖𝒎𝒃𝒆𝒓 𝒐𝒇 𝒑𝒆𝒓𝒊𝒐𝒅𝒔)

A nominal rate may be calculated for any time period longer than
the time period stated. For example, the interest of 1.5% per
month is the same as each of the following nominal rates.

Time period Nominal rate by equa- What This is

tion

24 Months 15 × 24 = 36% Nominal rate per 2 years

12 Months 15 × 12 = 18% Nominal rate per 2 months

6 Months 15 × 6 = 9% Nominal rate per 2 months
3 Months 15 × 3 = 4.5% Nominal rate per 2 months

A nominal rate does not account the frequency of compounding.

They all have the format “𝑟% per time period”. Nominal rate
can be misleading, then we need an alternative way to quote in-
terest rates. The effective interest rate is then applied. An
effective interest rate is a true, periodic interest rate and it
is a that applies for a stated period. It is a conventional to
use the year as the standard time.

54
3.2.2 Effective rate of interest
(comparing interest rates) Suppose Bank A offers savings account
with a 4.9% simple interest rate, Bank B offers savings accounts
with a 4.8% rate compounded monthly. Where should you put your
money?

To answer this question, we consider what we called effective

annual yield. The effective annual is the simple interest rate
that gives the same yearly return as compound interest rate. To
find this rate, use the formula
𝒓 𝒏
𝒓𝒆𝒇𝒇 = (𝟏 + )
𝒏
The general formula for effective rate of interest
𝒓 𝒏
𝒓𝒆𝒇𝒇 = (𝟏 + ) − 𝟏
𝒏
Where
𝑟𝑒𝑓𝑓 : the effective rate of interest

𝑟: annual interest rate

𝑛: number of compounding periods per year

Example
Find the effective rate of interest corresponding to nominal
rate of 6% per year compounded
a) Annually
b) Semi-annually
c) Quarterly
d) Monthly
e) Daily

55
Solution
Do all the calculations!!!!!!!!!!!!!

3.3. Simple Interest

Words to remember
✓ Interest: the amount of money that you pay to borrow money
or the amount of money that you earn on a deposit.
✓ Annual interest rate: the percent of interest that you pay
for money borrowed or earn for money deposited.
The simple interest formula is given by
𝑰 = 𝑷𝒓𝒕
Where
𝐼 is the interest earned
𝑃 is the principal or amount of money that you start out
with.
𝑟 annual interest rate as decimal
𝑡 time in years
Example
On July 10, 2005, Wendy borrowed R12 000 from her Aunt Nelda. If
Wendy agreed to pay a 9% annual rate of interest, calculate the
amount of interest she must pay if the loan is for
a) 1-year b) 5 months c) 15 months
Solution
a) 1 year: 𝐼 = 𝑃𝑟𝑡 = 12000 × 0.09 × 1 = 𝑅1 080
5
b) 5 months: 𝐼 = 𝑃𝑟𝑡 = 12000 × 0.09 × = 𝑅450
12
15
c) 15 months: 𝐼 = 𝑃𝑟𝑡 = 12000 × 0.09 × = 𝑅1 350
12

56
When an account earns interest, the interest is added to the
money in the account and the sum is called “balance”. The bal-
ance of A of an account that earns simple annual interest is the
sum of the principal (P) and the interest (Part).
Balance (or total) of simple interest formula is given by
𝑨 = 𝑷 + 𝑷𝒓𝒕
Where: A is the Balance or Sum or total

Example:
Luvuyo deposit R300 in a saving account that pays 4% simple an-
nual interest. Find his account balance after 9 months.
Solution
9
Write 9 months as year or 0.75 year
12

𝐴 = 𝑃 + 𝑃𝑟𝑡
𝐴 = 300 + 300(0.09)(0.75)
𝐴 = 309
∴ His account balance after 9 months is R309

Solving for Principal (P), rate (r) and time (t)

We can solve this variable (P, r, t) by simple use the simple
interest formula (𝐼 = 𝑃𝑟𝑡). We can use memory aid or hand cover
rule.

I
P r t

For example, cover 𝑷 with your hand, shows 𝑰 over 𝒓𝒕

57
 𝑰 𝑰 𝑰
∴𝑷= ∴𝒓= ∴𝒕=
𝒓𝒕 𝑷𝒕 𝑷𝒓

Example

Counting days and determining maturity value

The date on which the loan is be repaid is called the due date
or maturity. The maturity formula is given by
𝑴=𝑷+𝑰
Example:
Calculate the maturity value if the 9% of R12 000 loan if for
a) 1-year b) 5 Months c) 15 Months

Solution
a) 1 year: 𝑀 = 𝑃 + 𝐼 = 12000 + 1080 = 𝑅13 080
b) 5 months: 𝑀 = 𝑃 + 𝐼 = 12000 + 450 = 𝑅12 450
c) 15 months: 𝑀 = 𝑃 + 𝐼 = 12000 + 13350 = 𝑅13 350

3.4. Compound Interest

Word to remember
Compound interest: interest that earned both the principal and
any interest that has been earned previously.
The compound interest formula is given by
𝑨 = 𝑷(𝟏 + 𝒓)𝒕
Where

58
 𝐴 amount of money in the account at the end of the time
period
𝑃 principal amount
𝑟 annual interest rate
𝑡 time in years
This formula is pretty unrealistic. Usually banks will compound
interest over a much shorter period of time, maybe quarterly,
monthly or even daily. The general formula is
𝒓 𝒏𝒕
𝑨 = 𝑷 (𝟏 + )
𝒏
Where
𝑛: number of time the bank compounded per year
𝑡: number of years you keep the money in the account

Continuous compounding of interest

The general formula is given by
𝑨 = 𝑷𝒆𝒓𝒕
Where
𝑟: is the annual interest rate compounded continuously.
Example: 1
Write a compound interest function to model the situation. Then
find the balance after the given number of years. R50 000 in-
vested at a rate of 4.8% compounded monthly; 2 years.
Solution
𝑟 𝑛𝑡
𝐴 = 𝑃 (1 + )
𝑛
0.048 12(2)
𝐴 = 15000 (1 + ) = 16 508.22
12

59
Example 2
Find the accumulated amount after 4 year if R1000 is interested
at 6% per year compounded
a) Daily (assume a 365-day year) b) continuously
Solution

Do all the calculations!!!!!!!!!!!!!!!!!

3.4.1. Present and Future Value

Suppose now that Emihle are considering purchasing a security
which pays a yearly 10% fixed rate of return with daily com-
pounding. How much should HE invest now if he wants to have
R1 000 000 in 30 years.
To answer this question, we need to consider present and future
value. In this case, the present value of our security is the
initial investment P and our future value is R1 000 000 which is
our accumulated amount A, we solve the equation
𝒓 𝒏𝒕
𝑨 = 𝑷 (𝟏 + )
𝒏
Where
A is future value
And the present value is given by
𝒓 −𝒏𝒕
𝑷 = 𝑨 (𝟏 + )
𝒏
Example:
Find the present value of R 10 000 due in 2 years’ time if the
interest rate 6% compounded quarterly.

60
Solution

𝑟 −𝑛𝑡 0.06 −4(2)

𝑃 = 𝐴 (1 + ) = 10000 (1 + )
𝑛 4

Tutorial 6
1. Mbuso deposited R4 000 into account paying 6% annual inter-
est compounded quarterly, how much money will be in the ac-
count after 5 years?

2. The company deposited R6 500 into account paying 8% annual

interest compounded monthly, how much money will be in the
account after 7 years?

3. How much money would need to deposit today at 9% annual in-

terest compounded monthly to have R12 000 in the account
after 6 years?

4. If you deposited R5 000 into account paying 6% annual in-

terest compounded monthly, how long until there is R8 000
in the account?

5. At 3% annual compounded monthly, how long will it take to

double your money? If we start with R100 and FV=200.

61
6. Find the effective interest rate (correct to 3 decimal
places) if
a) 15% compounded monthly b) 16% compounded
quarterly
c)12% compounded half-yearly d) 5% compounded daily

7. How long will it take for an investment of R8 000 to mature

to R15 000 at nominal interest rate of 11% compounded
a) Annually b) Monthly
c) Quarterly d) Continuously

8. Find the present value of R16 000 due in 8 years’ time if

the interest rate in 12% compounded half-yearly.
9. Mr Sibiya want to start a small business in Jozini. He bor-
rows R10 000 from Capitec bank at a 9% for 5 years. Find
the interest he will pay on this loan.

10. Luthando get a student loan from NSFAS to pay her edu-
cational expenses this year. Find the interest on the loan
if she borrowed R2 000 at 8% for 1 year.

11. You are tired at the end of the semester and decide to
borrow R500 to go on a trip to Jozini Tiger Lodge. You go
to ABSA bank and borrow the money at 11% for 2 years.
a) Find the interest you will pay on the loan

62
 b) How much will you have to pay the bank at the end of
the 2 years?

12. For this problem, calculate the periodic rate semi-an-

nually, quarterly, monthly and daily
a) 8% b) 7% c) 7.5%

13. Jessca leans a friend R700 at 5% simple interest for 3

years. What is the maturity rate?

14. Messi decide to pay off a 9% R3000 loan early. The

bank tells him that he owes R117 interest. Assuming the
bank uses a 365-day year. For how many days he being
charged interest?

15. Vuyo borrow R200 from Emihle and agree to repay him
R225 (principal+interest) in 18 months. What interest rate
is he paying?

16. Mawenza open a checking account. He paid 3% interest

on the average balance but charged R7 monthly charge. As-
suming that interest is paid monthly, calculate the average
daily balance he must maintain to offset the R7 monthly
charge.

63
 17. A principal of R2000 is placed in a savings account at
3% per annum compounded annually. How much is in the ac-
count after one year, two years and three years?

18. What would R1000 become in a saving account at 3% per

year for 3 years when the interest is not compounded (sim-
ple interest)? What would the same amount become after 3
years with the same rate but compounded annually?

19. R1200 is placed in an account at 4% compounded contin-

uously for 2 years. It is then withdrawn and placed in an-
other bank at the rate of 5% compounded continuously for 4
years. What is the balance in the second account after the
4 years? (compare with the two previous problem).

20. A person deposited R1,000 in a 2% account compounded

continuously. In a second account, he deposited $500 in an
8% account compounded continuously. When will the total
amounts in both accounts be equal? When will the total
amount in the second accounts be 50% more than the total
amount in the second account?

Practice Problems

64
Now it is your turn to try a few practice problem on your own.
Work on each of the problems below.

1. If you deposit R4500 at 5% annual interest compounded quar-

terly, how much money will be in the account af-
ter 10 years

2. If you deposit R4000 into an account paying 9% annual in-

terest compounded monthly, how long un-
til there is R10000 in the account?
3. If you deposit R2500 into an account paying 11% annual in-
terest compounded quarterly, how long un-
til there is R4500 in the account?

4. How much money would you need to deposit today at 5% an-

nual interest compounded monthly to have R20000 in the ac-
count after 9 years?

5. If you deposit R6000 into an account paying 6.5% annual in-

terest compounded quarterly, how long un-
til there is R12600 in the account?
6. If you deposit R5000 into an account paying 8.25% an-
nual interest compounded semiannually, how long un-
til there is R9350 in the account

65
CHAPTER 4: Annuities
Learning Objective:
1. Distinguish between an ordinary annuity and an annuity due,
and calculate present and future value of each.
2. Distinguish between the concepts of future value and present
value.
3. Calculate the present value of a level perpetuity and a
growing perpetuity.
4. Amortization and sinking Funds

4.1. ANNUITIES
Annuity: is a series of equal payments that are made at the end
of equidistant points in time such as monthly, quarterly, or an-
nually over a finite period of time.
OR
An annuity is a sequence of cash payments made at fixed time in-
tervals for a fixed period of time. Originally, annuities were
payments made every year. They have now been extended to have
any time interval (months, quarters, etc...) called the payment
period. Annuities can be classified by when the payments are
made. Annuities whose payments are made at the end of the period
are called ordinary annuities. Annuities whose payments are made
at the beginning of the period are called annuity-due. A simple
annuity is an annuity in which the period of payments is identi-
cal to the period of interest compounding. A complex annuity is
an annuity in which the period of payments and period of inter-
est compounding are different. A complex annuity can be trans-
lated into a simple annuity by replacing the interest rate with

66
an appropriate effective interest rate. In this class we will
only work with ordinary annuities, annuity-due and deferred an-
nuity.

Example: House rents, mortgage payments, instalment payments on

automobiles, and interest payments on money invested.

Some words to know:

Sinking Fund: A savings fund, often to replace equipment at a
future date.
Discounting: Finding a present value.
Trust fund: A present value from which periodic withdrawals are
made until the trust fund is used up.
NB! In general, LOANS and TRUST FUNDS are PRESENT VALUES. SAV-
INGS are FUTURE VALUES (until you start to spend the amount
saved.)

4.1.1. Present Value of an Ordi-

nary Annuity
If payments are made at the end of each period, the annuity is
referred to as ordinary annuity. The present value (P) of an or-
dinary annuity measures the value today of a stream of cash
flows occurring in the future. For example, we will compute the
PV of ordinary annuity if we wish to answer the question: what
is the value today equivalent of receiving every year for the
next years if the interest rates are fixed?

To calculate the present value of an ordinary annuity the fol-

lowing formula is used:

67
 𝟏 − (𝟏 + 𝒊)−𝒏
𝑷𝒏 = 𝑹 [ ]
𝒊
𝑃𝑛 = Present value
R = annuity payment deposited or received at the end of each pe-
riod (periodic payment)
𝑖=Interest rate according to the period. Can be calculated by
𝑖 = 𝑟/𝑚 𝑟 =Interest rate 𝑚 =period
𝑛 total time period (number of payments/periods), calculated by
𝑛 =𝑡×𝑚 𝑡 time in years

Example:
What is the present value of an annuity of R1,500 payables at
the end of each 6-month period for 2 years if money is worth 8%,
compounded semiannually?
Solution:
𝑅 = 1500 𝑖 = 0.08/2 = 0.04 𝑛 = (2)(2) = 4

1 − (1 + 𝑖)−𝑛 1 − (1 + 0.04)−4
𝑃𝑛 = 𝑅 [ ] = 1500 [ ] = 𝑅5 444.84
𝑖 0.04

4.1.2. Future Value of ordinary

annuity
If an amount R is deposited at the end of each period for n pe-
riods in an annuity that earns interest at a rate of 𝑖 per pe-
riod, then the future value of the annuity will be:
(𝟏 + 𝒊)𝒏 − 𝟏
𝑺 = 𝑹[ ]
𝒊

68
𝑆 = Future Value 𝑟 =Interest rate
𝑅 = periodic payment 𝑚 =period
𝐼=Interest rate according to the period. Can be calculated by
𝑖 = 𝑟/𝑚
𝑛 total time period, calculated by 𝑛 = 𝑡 × 𝑚
𝑡 time in years

Example:
R200 is deposited at the end of each quarter in an account that
pays 4%, compounded quarterly. How much money will we have in
the account in 2 years and 3 months?

Solution:
0.04 (1+0.01)9 −1
𝑛 = (4)(2.25) = 9, 𝑖 = = 0.01 𝑆 = 200 [ ] = 𝑅1873.71
4 0.01

4.2.1. Present Value of an Annu-

ity Due
An annuity due is an annuity in which all the cash flows occur
at the beginning of the period, so interest accumulates for one
extra period. The first payment is made at time 0,and the last
payment is made at time 𝑛 − 1.
Since with annuity due, each cash flow is received one year ear-
lier, it present value will be discounted back for one less pe-
riod. The present value of an annuity due is computed by:

69
 𝟏 − (𝟏 + 𝒊)−𝒏
𝑷(𝒏, 𝒅𝒖𝒆) = 𝑹[ ] (𝟏 + 𝒊)
𝒊
Example:
Suppose that a court settlement results in a R750,000 award. If
this is invested at 9% compounded semi-annually, how much will
it provide at the beginning of each half-year for a period of 7
years?
𝑃(𝑛, 𝑑𝑢𝑒) = 𝑅750000 𝑛 = (2)(7) = 14 𝑖 = 0.09/2 = 0.045

1 − (1 + 0.045)−14
750000 = 𝑅 [ ] (1 + 0.045)
0.045
750000
𝑅= = 70 205.97
10.682852

4.2.2. Future Value of an Annuity

Due
The computation of future value of an annuity due requires com-
pounding the cash flows for one additional period, beyond an or-
dinary annuity. The following formula calculates future value:
(𝟏 + 𝒊)𝒏 − 𝟏
𝑺𝒅𝒖𝒆 = 𝑹[ ] (𝟏 + 𝒊)
𝒊
Example:
Find the future value of an investment if R150 is deposited at
the beginning of each month for 9 years and the interest rate is
7.2%, compounded monthly.
Solution:

70
𝑅 = 𝑅150 𝑛 = (9)(12) = 108 𝑖 = (0.072/12) = 0.006

(1 + 𝑖)𝑛 − 1
𝑆𝑑𝑢𝑒 = 𝑅[ ] (1 + 𝑖)
𝑖
(1 + 0.006)108 − 1
= 150. [ ] (1 + 0.006)
0.006
= 𝑅22 836. 59

4.3. Deferred Annuity

A deferred annuity is characterized by a payment which is made at
some later date, rather than the beginning or end of the time
period. The following formula calculates the present value of the
deferred annuity:
𝟏 − (𝟏 + 𝒊)−𝒏
𝑷(𝒏,𝒌 ) = 𝑹[ ] (𝟏 + 𝒊)−𝒌
𝒊
𝑃(𝑛,𝑘 ) = Present Value

𝑅 = periodic payment

𝑖 = Interest rate according to the period.

𝑛 = total time period,
𝑘 = deferred periods * compounded periods

Example:
A deferred annuity is purchased that will pay R10,000 per quarter
for 15 years after being deferred for 5 years. If money is worth
6% compounded quarterly, what is the present value of this annu-
ity?

71
Solution:
𝑅 = 10 000 𝑛 = 4(15) = 60 𝑘 = (5)(4) = 20
𝑖 = 0.06/4 = 0.015

1 − (1 + 0.015)−60
𝑃(60,20 ) = 10000 [. ] (1 + 0.015)−20 = 𝑅292 386.85
0.015

4.4. Amortization and Sinking

Funds

4.4.1. Sinking fund

Definition: Any account that is established for accumulating
funds to meet future obligations or debts. For example, an indi-
vidual might establish a sinking fund for the purpose of dis-
charging a debt at future data.
The sinking funds payment is defined to be the amount that must
be deposited into an account periodically to have a given future
amount. To derive the sinking fund payment formula, we use alge-
braic techniques to rewrite the formula for the future value of
an annuity and solve for the variable R:
𝑺∗𝒊
𝑹=( )
(𝟏 + 𝒊)𝒏 − 𝟏
Where all the variables have the same meaning as for annuities.

Example 1:
SSTT121 students want to save up to R80 000 and they have found
an account that will pay 8% compounded quarterly. How much will

72
they have to deposit every year in order to have a value of
R80 000 in 17 years?
Solution:
𝑟 0.08
In this case 𝑖 = = = 0.02, 𝑛 = (4)(17) = 68, 𝑆 = 80 000
𝑚 4

80000 ∗ 0.02
𝑅=( ) = 𝑅562.54
(1 + 0.02)68 − 1
Example 2:
A bond issue is approved for building a Marina in a city. The
city is required to make regular payments every 3 months into a
sinking fund paying 5.4% compounded quarterly. At the end of 10
years, the bond obligation will be retired with a cost of
R5 000 000. How much will the city have to pay each quarter?

Solution:
𝑟 0.054
Given 𝑖 = = = 0.1125, 𝑛 = (4)(10) = 40, 𝑆 = 5 000 000
𝑚 4

5000000 ∗ 0.1125
𝑅=( ) = 𝑅95 094.67
(1 + 0.1125)40 − 1

4.4.2. Amortization
Defn: is the process of paying off a debt. The formula for pre-
sent value of an annuity will allow us to model the process of
paying off a loan or other debt. The reason the formula is the
same is because receiving payments from your savings account is
essentially the bank repaying you the money you loaned them by
depositing it into savings account.
𝑷∗𝒊
𝑹=
[𝟏 − (𝟏 + 𝒊)−𝒏 ]

73
Where all the variables have the same meaning as for annuities.
Example 1:
Suppose you take out a 5-year, R25 000 loan from your bank to
purchase a new car. If your bank gives you 1% interest com-
pounded monthly on the loan and make equal monthly payments, how
much will your monthly payment be?
Solution:
Since the loan is R25 000 and it is paid off, the present value
will be P=R25 000. The interest rate is r=0.01 and the com-
pounded monthly, m=12. The loan lasts for 5 years, so we get

𝑃∗𝑖
𝑅= = 𝑅427,3 …
[1 − (1 + 𝑖)−𝑛 ]
Example 2:
If you sell your car to someone for R2 400 and agree to finance
it at rate 1% per month on the unpaid balance, how much should
you receive each month to amortize the loan in 24 months? How
much interest will you receive?
R = R112,98 I = R 311, 52

4.4.2.1. Amortization Schedules

Suppose you are amortizing a debt by making equal payments, but
then decided to pay off the debt with on lump-sum payment. How
much do you find the “pay-off” balance of the debt? (E.g., you
take out a 5-year loan with monthly payments for a car, but after
3-years of making payments you decide to just make one final
payment to retire the debt.). This “pay-off” is very useful,
even if you are not retiring the debt, but refinancing it. When
refinancing a debt, you are essentially making out a new loan to

74
pay-off the previous debt, so you need to know how much unpaid
balance remains on the account. When you are making payments into
an amortization, at the beginning, a large part of your payment
goes towards interest, while later, a larger goes towards the
unpaid balance. We can see how much of each payment goes towards
interest and how much towards unpaid balance by creating an amor-
tization schedule.
Example:
Construct the amortization schedule for a R1 000 debt that is to
be amortized in 6 equal monthly payments at 1.25% interest per
month on the unpaid balance.
Solution:
The first step in this process is to compute the required monthly
payment using the amortization formula
1000 ∗ 0.0125
𝑅= = 𝑅174.03
[1 − (1 + 0.0125)−6 ]

Now, to figure out how much of the payment goes towards interest
and how much towards unpaid balance, we compute the interest due
at the end of the first month:
𝑅1000(0.0125) = 𝑅12.50
And so the amount of the payment that goes towards the unpaid
balance is:
𝑅174.03 − 𝑅12.50 = 𝑅161.53
Thus, the unpaid balance at the end of the first month is
𝑅1000 − 𝑅161.53 = 𝑅838.47.
To compute the breakdown for the next month, we do the same
thing, but with new unpaid balance. The interest due at the end
of month 2:
𝑅838.47(0.0125) = 𝑅10.48

75
Amount of payment towards unpaid balance:
𝑅174.03 − 𝑅10.48 = 𝑅163.55
And so the unpaid balance at the end of 2 months is
𝑅838.47 − 𝑅163.55 = 𝑅674.92.
To compute the breakdown of the next month, we do the same
thing, but with new unpaid balance and so. Complete the table
below.

Payment Num- Payment Interest Unpaid Bal- Unpaid

ber ance Reduc- Balance
tion

0 - - - R1 000
1 R174.03 R12.50 R161.53 R838.47
2 R174.03 R10.48 R163.55 R674.92
3 R174.03 R8.44 R165.59 R509.33

4 R174.03 R6.37 R167.66 R341.67

5 R174.03 R4.27 R169.76 R171.91

6 R174.03 R2.15 R171.91 R0.00

Total R1 044.21 R44.21 R1 000

4.5. Perpetuities

Definition: A perpetuity is an annuity where payments start on a

fixed date and continues forever or has no maturity.
For example, a dividend stream on a share of preferred stock.
There are two basic types of perpetuities:

76
 ➢ Growing perpetuity in which cash flows grow at a constant
rate, g, from period to period.
➢ Level perpetuity in which the payments are constant rate from
period to period.

4.5.1. Present value of a growing

perpetuity
In growing perpetuities, the periodic cash flows grow at a con-
stant rate each period. The present value of a growing perpetuity
can be calculated using a simple mathematical equation
𝑹𝒑𝒆𝒓𝒊𝒐𝒅 𝟏
𝑷𝑽𝒈𝒓𝒐𝒘 =
𝒊−𝒈
Where
✓ 𝑃𝑉𝑔𝑟𝑜𝑤 = present value of a growing perpetuity
✓ 𝑅𝑝𝑒𝑟𝑖𝑜𝑑 1 payment made at the end of first period
✓ 𝑖 rate of interest used to discount the growing perpe-
tuity’s cash flows
✓ 𝑔 the rate of growing in the payment of cash flows from
period to period
✓ 𝑖>𝑔

4.5.2. Present value of a level

perpetuity
The Present value of a level perpetuity can be calculated using a
simple mathematical equation
𝑹
𝑷𝑽𝑳𝒗𝒍 =
𝒊
77
Where
✓ 𝑃𝑉𝐿𝑣𝑙 the present value of a level perpetuity
✓ 𝑅 the constant amount provided by the perpetuity
✓ 𝑖 the interest (or discount) rate per period

Example 1: What is the present value of R 600 perpetuity at 7%

discount rate?
Solution:
𝑅
𝑃𝑉𝐿𝑣𝑙 =
𝑖
600
𝑃𝑉𝐿𝑣𝑙 = = 𝑅8 571.43
0.07

Tutorial 7
1. Andile and Buhle both take out loans for R2 million. Andile
makes equal monthly repayments over 20 years with interest
charged at 16% p.a. compounded monthly. Buhle makes equal
monthly repayments over 25 years with interest charged at
13.5% p.a. compounded monthly.

a) Without making any calculations, determine whose monthly

instalments will be lowest.
b) What is the difference between the total amount of interest
paid by Andile and Buhle?
c) What is the amount outstanding on Buhle’s loan when Andile
has finished paying his loan?
d) If Andile deferred payments for 5 years, and then paid the
debt over 20 years at 16% p.a. compounded monthly, how much
interest will he pay in total?

78
2. A satelite TV subscription is R550 per month, payable in
advance. They offer a deal: pay in advance for a year but
only pay R6 050. How much will you save on this deal if
interest is available to you at 7% p.a. compounded monthly?

3. You make monthly deposits of R100 into an annuity and after

30 years wish to accumulate R160 000. What annual rate com-
pounded monthly will be required to this? (r=0.083480405763)

4. You desire to save R200 000 for retirement. You can afford
to save R125 a month into a mutual fund that averages 7.75%
compounded monthly. How many years will be needed to do
this? (t=31.426831333098)

5. You have found the house of your dreams. The selling price
is R175 000 with an interest rate of 5.5% compounded
monthly. Determine the monthly house payment if the loan is
for:
a) 30 years (R993.64)
b) 15 years (R1429.90)

6. Suppose a R1000 payment is made at each quarter and the

money in the account is compounded quarterly at 6.5% inter-
est for 15 years. How much is in the account after the 15
years’ period? (R100,336.68)

7. How much must Harry save each month in order to buy a new
car for R12 000 in three years if the interest rate is 6%
compounded monthly? (R305.06)

8. A business sets up a sinking fund so that it will be able

to pay off bonds it has issued when they mature. If it de-
posits R12 000 at the end of each quarter in an account

79
 that earns 5.2% interest, compounded quarterly, how much
will be in the sinking fund after 10 years? (R624 369.81)

9. A firm borrows R6 million to build a small factory. The

bank requires it to set up a R200 000 sinking fund to re-
place the roof after 15 years. If the film’s deposits earn
6% interest, compounded annually, find the payment it
should make at the end of each year into the sinking fund.
(R8592.55)

10. Mr Luvuyo want to buy a house. The house will cost

R120 000. He put 5% down and then plan to pay off the house
for next 30 years with monthly payments. What payments
should he make to pay off the loan if the interest rate is
7.5% compounded monthly? How much interest did he pay?

11. Write an amortization schedule for the first 4 months

for problem 10.

80
CHAPTER 5: Index Numbers
Learning objectives
After studying this lesson, you will be able to:

➢ Define index numbers and explain their uses

➢ Identify and use the following methods for construction of
index numbers
➢ Explain the advantages of different methods of construction

5.1. Introduction
Index numbers has become one of the most widely used method for
judging the pulse of economy. Index numbers are convenient de-
vices for measuring relative changes of differences from time to
time or from place to place.

5.1.1. INDEX NUMBERS-DEFINITION

Definition: An index number is a ratio or an average of ratios
expressed as a percentage, two or more time periods are in-
volved, one of which is the base time period. The value at the
base time period serves as the standard point of comparison.
Some prominent definitions, given by statisticians, are given
below:
According to the Spiegel:
"An index number is a statistical measure, designed to measure
changes in a variable, or a group of related variables with re-
spect to time, geographical location or other characteristics
such as income, profession, etc."

81
According to Patternson:
"In its simplest form, an index number is the ratio of two index
numbers expressed as a percent. An index is a statistical meas-
ure, a measure designed to show changes in one variable or a
group of related variables over time, with respect to geograph-
ical location or other characteristics".

According to Tuttle:
"Index number is a single ratio (or a percentage) which measures
the combined change of several variables between two different
times, places or situations". We can thus say that index numbers
are economic barometers to judge the inflation (increase in
prices) or deflationary (decrease in prices) tendencies of the
economy. They help the government in adjusting its policies in
case of inflationary situations.

5.1.2. CHARACTERISTICS OF INDEX

NUMBERS
An index number is a statistical measure of changed in repre-
sentative group of individual data points. The data may be de-
rived from any number of sources, including company performance,
prices, productivity and employment. Following are some of the
important characteristics of index numbers:

✓ Index numbers are expressed in terms of percentages to

show the extent of relative change

✓ Index numbers measure relative changes. They measure the

relative change in the value of a variable or a group of
related variables over a period of time or between places.

✓ Index numbers measures changes which are not directly

measurable. The cost of living, the price level or the
82
 business activity in a country are not directly measurable
but it is possible to study relative changes in these ac-
tivities by measuring the changes in the values of varia-
bles/factors which effect these activities.

5.1.3. USES OF INDEX NUMBERS

1) Index numbers are economic barometers. They measure the
level of business and economic activities and are therefore
helpful in gauging the economic status of the country.

2) Index number helps in formulation of policy decisions. In-

dex numbers relating the output (production), volume of im-
ports and exports, volume of trade foreign exchange reverse
and other financial matters are indispensable for any gov-
ernment organisation as well a private business concerns in
efficient planning and formulating policy decision.

3) Index numbers reveal trends and tendencies. Index numbers

reflect the pattern of change in the level of a phenomenon.

4) Index numbers help to measures the purchasing power of

money. Once the price index is computed, then the earnings
of a group of people or class is adjusted with a price in-
dex that provides an overall view of the purchasing power
for the group.

5) Consumer price indices are used for deflating. The price

index number is useful in deflating the national income to
remove the effect of inflation over a long term, so that we
may understand whether is any change in the real income to
the people or not.

5.1.4. TYPES OF INDEX NUMBERS

83
Index numbers are names after the activity they measure. Their
types are as under:

Price Index: Measure changes in price over a specified period of

time. It is basically the ratio of the price of a certain number
of commodities at the present year as against base year.

Quantity Index: As the name suggest, these indices pertain to

measuring changes in volumes of commodities like goods produced
or goods consumed, etc.

Value Index: These pertain to compare changes in the monetary

value of imports, exports, production or consumption of commodi-
ties.

5.2. METHODS OF CONSTRUCTION IN-

DEX NUMBERS
Construction of index numbers can be divided into two types:

a) Unweighted indices
b) Weighted indices

5.2.1. Unweighted indexes

In many situations we wish to combine several items and develop
an index to compare the cost of this aggregation of items in two
different time periods. For example, we might be interested
in an index for items that relate to the expense of running and
maintaining an automobile. The items in the index might include
tires, oil changes, and gasoline prices. Or we might be inter-
ested in a college student index. This index might include the

84
cost of books, tuition, housing, meals, and entertainment. There
are several ways we can combine the items to determine the in-
dex.

The following are the methods of constructing unweighted index

numbers:
i. Simple Aggregative method
ii. Simple average of price relative method

5.2.1.1. Simple Aggregative

Method
This is a simple method for constructing index numbers. In this,
the total of current year prices for various commodities is di-
vided by the corresponding base year price total and multiplying
the result by 100. The formula is

∑ 𝑷𝒕
𝑷= × 𝟏𝟎𝟎
∑ 𝑷𝒐
Where
P is the current price Index number.
𝑃𝑡 the total of commodity prices in the current year.
𝑃0 the total of same commodity prices in the base year.

Example: Construct the price index number for 2003, taking the
year 2000 as base year

Commodity Price in year 2000 Price in year 2003

A 60 80

B 50 60

C 70 100

D 120 160

E 100 150

Solution: Calculation of simple Aggregative index number for

2003 against the year 2000.

85
Commodity Price in year 2000 Price in year 2003

A 60 80

B 50 60

C 70 100

D 120 160

E 100 150

Total ∑ 𝑃0 = 400 ∑ 𝑃𝑡 = 550

Here, ∑ 𝑃0 = 400 and ∑ 𝑃𝑡 = 550

∑ 𝑃𝑡 550
∴𝑃= × 100 = × 100 = 137.5
∑ 𝑃𝑜 400

i.e. the price index for the year 2003, taking 2000 as base
year, is 137.5, showing that there is an increase of 37.5% in
the prices in 2003 as against 2000.

Example 2: Compute the index number for the years 2001, 2002,
2003 and 2004, taking 2000 as base year, from the following
data:

Year 2000 2001 2002 2003 2004

Price 120 144 168 204 216

Solution: Price relatives for different years are

86
2000 120
× 100 = 100
120
2001 144
× 100 = 120
120
2002 168
× 100 = 140
120
2003 204
× 100 = 170
120
2004 216
× 100 = 180
120

∴ Price index for different years are:

Year 2000 2001 2002 2003 2004

Price-Index 100 120 140 170 180

5.2.1.2. Simple Average of Price

Relatives Method
In this method, the price relatives for all commodities is cal-
culated and then their average is taken to calculate the index
number.

Thus,
𝑷
∑ 𝒕 ×𝟏𝟎𝟎
𝑷𝟎
𝑷= ,
𝑵

if A.M. is used as average where P is the price index, N is the

number of items, 𝑃𝑡 the total of commodity prices in the current
year. 𝑃0 the total of same commodity prices in the base year.

Example: Construct by simple average of price relative method

the price index of 2004, taking 1999 as base year from the fol-
lowing data:

87
Commodity A B C D E F

Price (in 1999) 60 50 60 50 25 20

Price (in 2004) 80 60 72 75 37.5 30

Solution:
Commodity Price (in 1999) Price (in 2004) 𝑃𝑡
(∑ × 100)
𝑃0
(in Rs.) [𝑃𝑜 ] (in Rs.) [𝑃𝑡 ]

A 60 80 133.3

B 50 60 120.0

C 60 72 120.0

D 50 75 150.0

E 25 37.5 150.0

F 20 30 150.0

823.33

𝑃𝑡
∑ × 100 823.33
𝑃0
∴𝑃= = = 137.22
𝑁 6

∴ Price index for 2004, taking 1999 for base year is R137.22.

5.2.2. Weighted indexes

To meet the weakness of the simple or unweighted methods, we
weigh the price of each commodity by a suitable factor often
taken as the quantity or the volume of the commodity sold during
the base year or some typical year. These indices can be classi-
fied into broad groups:
1. Weighted Aggregative Index
2. Weighted Average of Relatives

88
Weighted Aggregative Index: Under this method we weigh the price
of each commodity by a suitable factor often taken as the quan-
tify or value weight sold during the base year or the given year
or an average of some years. The choice of one or the other will
depend on the importance we want to give to a period besides the
quantify used. The indices are usually calculated in percent-
ages. The various alternatives formulae in use are:
a) Laspeyres Index: In this index base year quantities are
used as weights:
∑ 𝑷𝒏 𝑸𝟎
𝐋𝐚𝐬𝐩𝐞𝐲𝐫𝐞𝐬 𝐈𝐧𝐝𝐞𝐱 = × 𝟏𝟎𝟎
∑ 𝑷𝟎 𝑸𝟎
Where 𝑃𝑛 : the current price
𝑃0 : the price in the base period
𝑄0 : the quantity used in the based period.

b) Passche’s Index: In this Index current year quantities

are used as weights:
∑ 𝑷𝒏 𝑸𝒏
𝐏𝐚𝐬𝐬𝐜𝐡𝐞’𝐬 𝐈𝐧𝐝𝐞𝐱 = × 𝟏𝟎𝟎
∑ 𝑷𝟎 𝑸𝒏
Where 𝑃𝑛 : the current price
𝑄𝑛 : the current quantity
𝑃0 : the price in the base period
𝑄0 : the quantity used in the based period.

c) Methods based on some typical Period:

𝑷𝒏 𝑸𝒕
𝑰𝒏𝒅𝒆𝒙 = ∑ × 𝟏𝟎𝟎
𝑷𝒐 𝑸𝒕
The subscript t stands for some typical period of years the
quantities of which are used as weight.

89
NOTE: Indices are usually calculated as percentages using the
given formulae.

How do we decide which index to use? When is Laspeyres’ most

appropriate and when is Paasche’s the better choice?

Laspeyres’
Advantages Requires quantity data from only the base period.
This allows a more meaningful comparison over
time. The changes in the index can be attributed
to changes in the price.

Disadvantages Does not reflect changes in buying patterns over

time. Also, it may overweight goods whose prices
increase.
Paasche’s

Advantages Because it uses quantities from the current pe-

riod, it reflects current buying habits.

Disadvantages It requires quantity data for each year, which

may be difficult to obtain. Because different
quantities are used each year, it is impossible
to attribute changes in the index to changes in
price alone. It tends to overweight the goods
whose prices have declined. It requires the
prices to be recomputed each year.

Fisher’s Ideal Index

As noted above, Laspeyres’ index tends to overweight goods
whose prices have increased. Paasche’s index, on the other
hand, tends to overweight goods whose prices have gone down. In
an attempt to offset these shortcomings, Irving Fisher, in his
book The Making of Index Numbers, published in 1922, proposed an
index called Fisher’s ideal index. It is the geometric mean of
the Laspeyres and Paasche indexes. It is determined by taking
the kth root of the product of k positive numbers.

90
 𝑭𝒊𝒔𝒉𝒆𝒓′ 𝒔 𝑰𝒏𝒅𝒆𝒙 = √(𝐋𝐚𝐬𝐩𝐞𝐲𝐫𝐞𝐬’ 𝐢𝐧𝐝𝐞𝐱 )(𝐏𝐚𝐚𝐬𝐜𝐡𝐞’𝐬 𝐢𝐧𝐝𝐞𝐱)

∑ 𝑷𝒏 𝑸𝟎 ∑ 𝑷𝒏 𝑸𝒏
𝑭𝒊𝒔𝒉𝒆𝒓′ 𝒔 𝑰𝒏𝒅𝒆𝒙 = √ ×
∑ 𝑷𝟎 𝑸𝟎 ∑ 𝑷𝟎 𝑸𝒏

Weighted Average of relative Method: To overcome the disad-

vantage of a simple average of relative method, we can use
weighted average of relative method. Generally weighted arithme-
tic mean is used although the weighted geometric mean can also
be used. The weighted arithmetic mean of price relatives using
base year value weights represented by
𝑷𝒏
∑ × (𝑷𝒐 𝑸𝒐 ) ∑ 𝑷𝒏 𝑸𝟎
𝑷𝒐
× 𝟏𝟎𝟎 = × 𝟏𝟎𝟎
∑ 𝑷𝟎 𝑸𝟎 ∑ 𝑷𝟎 𝑸𝟎

Example: For this example;

a) Determine Laspeyres price index
b) Determine the Paasche price index
c) Fisher’s ideal index
d) Determine the weighted average of relative method

Construct the indexes:

Base Year Current Year
Commodities Price Quantity Price Quantity
A 4 3 6 2
B 5 4 0 4
C 7 2 9 2
D 2 3 1 5
Solution:
Commodi- 𝑷𝟎 𝑸𝟎 𝑷𝟏 𝑸𝟏 𝑷𝟎 𝑸𝟎 𝑷𝟏 𝑸𝟎 𝑷𝟎 𝑸𝟏 𝑷𝟏 𝑸𝟏
ties

91
A 4 3 6 2 12 18 8 12
B 5 4 0 4 20 0 20 0
C 7 2 9 2 14 18 14 18
D 2 3 1 5 6 3 10 5
Total Sum 52 63 52 59

Do all calculation!!!!!!!!!!!!

5.3. Value Index

A value index measures changes in both the price and quantities
involved. A value index, such as the index of department store
sales, needs the original base-year prices, the original base-
year quantities, the present-year prices, and the present-year
quantities for its construction. Its formula is:

∑ 𝑷𝒏 𝑸𝒏
𝑰𝒗𝒂𝒍𝒖𝒆 = × 𝟏𝟎𝟎
∑ 𝑷𝟎 𝑸𝟎

5.4. Deflating time series using

index numbers
Sometimes a price index is used to measure the real values in
economic time series data expressed in monetary units. For exam-
ple, GNP initially is calculated in current price so that the
effect of price changes over a period of time gets reflected in
the data collected. Thereafter, to determine how much the physi-
cal goods and services have grown over time, the effect of
changes in price over different values of GNP is excluded. The
real economic growth in terms of constant prices of the base
year therefore is determined by deflating GNP values using price
index. The formula for conversation can be stated as

92
 𝑪𝒖𝒓𝒓𝒆𝒏𝒕 𝑽𝒂𝒍𝒖𝒆
𝑫𝒆𝒇𝒍𝒂𝒕𝒆𝒅 𝑽𝒂𝒍𝒖𝒆 =
𝑷𝒓𝒊𝒄𝒆 𝒊𝒏𝒅𝒆𝒙 𝒐𝒇 𝒕𝒉𝒆 𝒄𝒖𝒓𝒓𝒆𝒏𝒕 𝒚𝒆𝒂𝒓

𝑩𝒂𝒔𝒆 𝑷𝒓𝒊𝒄𝒆 (𝑷𝟎 )

𝑶𝒓 𝑪𝒖𝒓𝒓𝒆𝒏𝒕 𝑽𝒂𝒍𝒖𝒆 ×
𝑪𝒖𝒓𝒓𝒆𝒏𝒕 𝑷𝒓𝒊𝒄𝒆 (𝑷𝒏 )

5.5. Shifting and splicing of in-

dex numbers
These refer to two technical points: (i) how the base period of
the index may be shifted, (ii) how two index covering different
bases may be combined into single series by splicing. If two or
more-time series have the same base period, they can be compared
directly. As an example, let suppose we are interested in the
trend in the prices of food, shelter, clothing and footwear, and
health and personal care over the last four years compared to
the base year that all of the consumer price indexes use the
same base. Thus, it can be said that the price of all consumer
items combined increased with a certain percentage (%) from the
base period. Likewise, shelter increased certain percentage (%),
clothing and footwear certain percentage (%), and so on.

Shifted Two Index Number Series

93
Year Original Price In- Shifted Price Index to base
dex 1990

1980 100 71.4

1981 104 74.3

1982 106 75.7

1983 107 76.4
1984 110 78.6

1985 112 80.0

1986 115 82.1

1987 117 83.6

1988 125 89.3

1989 131 93.6

1990 140 100.0

1991 147 105.0

The formula for shifted price index is given by:

𝑺𝒉𝒊𝒇𝒕𝒆𝒅 𝑷𝒓𝒊𝒄𝒆 𝑰𝒏𝒅𝒆𝒙

𝑶𝒓𝒊𝒈𝒊𝒏𝒂𝒍 𝑷𝒓𝒊𝒄𝒆 𝑰𝒏𝒅𝒆𝒙
= × 𝟏𝟎𝟎
𝑷𝒓𝒊𝒄𝒆 𝑰𝒏𝒅𝒆𝒙 𝒐𝒇 𝒕𝒉𝒆 𝒚𝒆𝒂𝒓 𝒐𝒏 𝒘𝒉𝒊𝒄𝒉 𝒊𝒕 𝒉𝒂𝒔 𝒕𝒐 𝒃𝒆 𝒔𝒉𝒊𝒇𝒕𝒆𝒅

Splicing two sets of price index numbers covering different pe-

riods of time usually required when there is a major change in
quantity weights. It may also be necessary on account of a new
method of calculation or the inclusion of new commodity in the
index.

94
 Splicing Two Index Number Series
Year Old Price index Revised Price Index Spliced Price In-
[1990=100] [1990=100] dex [1990=100]
1990 100.0 87.6

1991 102.3 89.6

1992 105.3 92.2

1993 107.6 94.2

1994 111.9 98.0

1995 114.2 100.0 100.0

1996 102.5 102.5

1997 106.4 106.4

1998 108.3 108.3

1999 111.7 111.7

2000 117.8 117.8

You will notice that the old series up to 1994 has to be con-
verted shifting to the base 1995 i.e., 114.2 to have a continu-
ous series, even when the two parts have different weights.

95
Tutorial 8
For exercises 1 – 2;
a) Determine the simple average of the price indexes.
b) Determine the aggregate price indexes for the two years.
c) Determine Laspeyres’ price index.
d) Determine the Paasche price index.
e) Determine Fisher’s ideal index.

1. An index of clothing prices for 2005 based on 1998 is to be

constructed. The clothing items considered are shoes and
dresses. The information for prices and quantities for both
years is given below. Use 1998 as the base period and 100
as the base value.

1998 2005
Item Price Quantity Price Quantity
Dress (each) 75 500 85 520
Shoes (each) 40 1200 45 1300

2. The prices and the numbers of various items produced by a

small machine and stamping plant are reported below. Use
2000 as the base.

2000 2005
Item Price ($) Quantity Price ($) Quantity
Washer 0.07 17 000 0.10 20 000
Cotter pin 0.04 125 000 0.10 130 000
Stove bolt 0.15 40 000 0.18 42 000
Hex nut 0.08 62 000 0.10 65 000

3. The number of items produced by Houghton Products for 1999

and 2005 and the wholesale prices for the two periods are:

96
 1999 2005
Item Produced Price Number Produced
Shear pins (box) 3 4 10000 9000
Cutting compound (500 g) 1 5 600 200
Tie rods (each) 10 8 3000 5000

a) Find the index of the value of production for 2005 using

1999 as the base period.
b) Interpret the index.
4. The Johnson Wholesale Company manufactures a variety of
products. The prices and quantities produced for April 1997
and April 2005 are:

1997 2005 1997 2005

Product Price Price Quantity Quantity Pro-
Produced duced
Small motor (each) 23.60 28.80 1 760 4 259
Scrubbing compound (litre) 2.96 3.08 86 450 62 949
Nails (pound) 0.40 048 9460 22 370

Using April 1997 as the base period, find the index of the value
of goods produced for April 2005.

97
CHAPTER 6: Time Series Analysis
Learning Objectives:

After studying this chapter, you should be able to:

➢ To define time series

➢ To define and differentiate time series components
➢ To do trend and seasonal analysis
➢ To plot data, smoothing curve and trend line
➢ To use historical data to forecast the future data

6.1. Time series

Definition: A time series is a sequence of data points being
recorded at specific times.
Time series data have a natural temporal ordering. This makes it
distinct from common data problems, where there is no natural
ordering of the observations, and from spatial data analysis,
where the observations typically relate to geographic locations.
A time series model will generally reflect the fact that obser-
vations close together in time will be more closely related than
observations further apart. In addition, time series models will
often make use of the natural one-way ordering of time so that
values for a given period will be expressed as being derived in
some way from past values, rather than future values.
Examples: Sales, temperature, rainfall, population, etc…
A time series may consist of any combination of the following
components:
Secular Trend (T)
A trend exists when there is a long-term increase or de-
crease in the data. It does not have to be linear. Some-
times we will refer to a trend “changing direction” when
it might go from an increasing trend to a decreasing trend.

98
Seasonal Variation (S)
A seasonal pattern exists when a series is influenced by
seasonal factors (e.g., the quarter of the year, the month,
or day of the week). Seasonality is always of a fixed and
known period.
Examples: In most geographical areas the temperature and
rainfall vary according to the season of the year
The sales of certain goods (e.g. clothing) and the occur-
rence of certain illness (e.g. flu) vary according to the
time of the year.
Cyclical Variations (C)
A cyclic pattern exists when data exhibit rises and falls
that are not of fixed period. The duration of these fluctu-
ations is usually of at least 2 years.

Irregular Variations (I)

When trend and cyclical variations are removed from a set

of time series data, the residual left, which may or may
not be random. Various techniques for analysing series of
this type examine to see “if irregular variation may be
explained in terms of probability models such as moving av-
erage or autoregressive models, i.e. we can see if any cy-
clical variation is still left in the residuals. These var-
iations occur due to sudden causes are called residual var-
iation (irregular variation or accidental or erratic fluc-
tuations) and are unpredictable, for example rise in prices
of steel due to strike in the factory, accident due to
failure of break, flood, earth quick, war etc.

99
1. The monthly housing sales (top left) show strong seasonality
within each year, as well as some strong cyclic behaviour with
period about 6–10 years. There is no apparent trend in the data
over this period.

2. The US treasury bill contracts (top right) show results from the
Chicago market for 100 consecutive trading days in 1981. Here
there is no seasonality, but an obvious downward trend. Possi-
bly, if we had a much longer series, we would see that this
downward trend is actually part of a long cycle, but when viewed
over only 100 days it appears to be a trend.
3. The Australian monthly electricity production (bottom left)
shows a strong increasing trend, with strong seasonality. There
is no evidence of any cyclic behaviour here.

100
4. The daily change in the Dow Jones index (bottom right) has no
trend, seasonality or cyclic behaviour. There are random fluctu-
ations which do not appear to be very predictable, and no strong
patterns that would help with developing a forecasting model.

6.2. Time series decomposition

We shall think of the time series 𝑦𝑡 as comprising three compo-
nents: a seasonal component, a trend-cycle component (containing
both trend and cycle), and a remainder component (containing an-
ything else in the time series). For example, if we assume an
additive model, then we can write

𝒚𝒕 = 𝑺𝒕 + 𝑻𝒕 + 𝑬𝒕,
where 𝑦𝑡 is the data at period 𝑡, St is the seasonal component
at period 𝑡, Tt is the trend-cycle component at pe-
riod 𝑡 and Et is the remainder (or irregular or error) component
at period 𝑡. Alternatively, a multiplicative model would be
written as

𝒚𝒕 = 𝑺𝒕 × 𝑻𝒕 × 𝑬𝒕.
The additive model is most appropriate if the magnitude of the
seasonal fluctuations or the variation around the trend-cycle
does not vary with the level of the time series. When the varia-
tion in the seasonal pattern, or the variation around the trend-
cycle, appears to be proportional to the level of the time se-
ries, then a multiplicative model is more appropriate. With eco-
nomic time series, multiplicative models are common.
An alternative to using a multiplicative model, is to first
transform the data until the variation in the series appears to
be stable over time, and then use an additive model. When a log
transformation has been used, this is equivalent to using a mul-
tiplicative decomposition because

𝒚𝒕 = 𝑺𝒕 × 𝑻𝒕 × 𝑬𝒕 is ⟺ to 𝒍𝒐𝒈𝒚𝒕 = 𝒍𝒐𝒈𝑺𝒕 + 𝒍𝒐𝒈𝑻𝒕 + 𝒍𝒐𝒈𝑬𝒕.

101
Sometimes, the trend-cycle component is simply called the
“trend” component, even though it may contain cyclic behaviour
as well.

6.3. Moving averages

The classical method of time series decomposition originated in
the 1920s and was widely used until the 1950s. It still forms
the basis of later time series methods, and so it is important
to understand how it works. The first step in a classical decom-
position is to use a moving average method to estimate the
trend-cycle, so we begin by discussing moving averages.

6.3.1. Moving average smoothing

A moving average of order m can be written as
𝒌
𝟏
̂𝒕 =
𝑻 ∑ 𝒀𝒕+𝒋
𝒎
𝒋=−𝒌

where 𝒎 = 𝟐𝒌 + 𝟏. That is, the estimate of the trend-cycle at

time 𝑡 is obtained by averaging values of the time series
within 𝑘 periods of 𝑡. Observations that are nearby in time are
also likely to be close in value, and the average eliminates
some of the randomness in the data, leaving a smooth trend-cycle
component. We call this an m-MA meaning a moving average of or-
der m.
NOTE: The result in the series is either a smooth curve or a
straight line. The moving average method produces a smooth
curve, while the straight line is obtained by using the of least
squares.
The general form of an equation for the trend is:
𝒚 = 𝒂 + 𝒃𝒙

102
Where 𝑎 is the intercept, 𝑏 is the slope and 𝑥 the code assigned
to the time. The time codes (𝑥) are assigned to increase in
equal steps as one progress through time. These codes are as-
signed to ensure that ∑ 𝑥 = 0. The way in which this done is as
follows:
✓ When n (the number of periods) is odd, the first time pe-
𝒏−𝟏
riod is assigned the code -( ) and for subsequent periods
𝟐
1 is added to the previous period’s code.
✓ When n (the number of periods) is even, the first time pe-
riod is assigned the code -(𝒏 − 𝟏) and for subsequent peri-
ods 2 is added to the previous period’s code.

The intercept; 𝑎 and the slope; 𝑏 can be calculated from

∑𝒚 ∑ 𝒙𝒚
𝒂= ̅
=𝒚 and 𝒃= ∑ 𝒙𝟐
𝒏

Example: Consider the sales of product for three successive

years. Calculate the MA(4), centred MA(4) and the trend line of
the series.

Year 1 Year 2 Year 3

𝑸𝟏 𝑸 𝟐 𝑸𝟑 𝑸 𝟒 𝑸𝟏 𝑸 𝟐 𝑸𝟑 𝑸 𝟒 𝑸𝟏 𝑸 𝟐 𝑸𝟑 𝑸 𝟒
10 8 12 14 8 16 19 15 12 18 16 13

Solution:
Since time series involve quarterly values, the moving average
is based on 4 successive values (of order 4). This can be writ-
ten as MA(4).
Calculation of moving averages:
10+8+12+14
1st Entry: = 11
4

103
 8+12+14+8
2nd Entry: = 10.5
4
12+14+8+16
3rd Entry: = 12.5
4

.
.
.
12+18+16+13
Last Entry: = 14.75
4

Calculation of Centred Moving Averages:

11+10.5
1st Entry: = 10.75
2
10.5+12.5
2nd Entry: = 11.5
2

The purpose of calculating centred moving averages is to have a

moving average corresponding (in time) to some of the observa-
tions.
Period Sales Time
𝒚 𝒙 𝒙𝟐 𝒙𝒚
𝑄1 10 -11 121 -110
𝑄2 8 -9 81 -72
𝑄3 12 -7 49 -84
𝑄4 14 -5 25 -70
𝑄1 8 -3 9 -24
𝑄2 16 -1 1 -16
𝑄3 19 1 1 19
𝑄4 15 3 9 45
𝑄1 12 5 25 60
𝑄2 18 7 49 126
𝑄3 15 9 81 135
𝑄4 13 11 121 143
𝒏 = 𝟏𝟐 ∑ 𝒚 =160 ∑ 𝒙 =0 ∑ 𝒙𝟐 =572 ∑ 𝒙𝒚 =152

152 38
Slope/gradient: 𝑏 = = = 0.266
572 143

104
 160 40
y-intercept: 𝑎 = = = 13.33′
12 3

The trend line (T) is defined by the following equation

40 38
𝑦= + 𝑥
3 143
Where 𝑥 = −1 in Year 2 𝑄2 𝑥 = 1 in Year 2 𝑄3

6.4. Seasonal Analysis

The seasonal influence is expressed as an index. A seasonal in-
dex of means that the activity in the season under consideration
is normal; an index above 100 mean an above normal activity and
one below 100 means below normal activity.
The following steps can be used to calculate seasonal indices:
➢ Calculate moving averages and centred moving averages.
➢ Calculate the seasonal ratio,

𝒚
𝑺𝒆𝒂𝒔𝒐𝒏𝒂𝒍 𝑹𝒂𝒕𝒊𝒐 = × 𝟏𝟎𝟎
𝑪𝒆𝒏𝒕𝒓𝒆 𝑴𝒐𝒗𝒊𝒏𝒈 𝑨𝒗𝒆𝒓𝒂𝒈𝒆

➢ Find the median of the seasonal ratios for each of the sea-
sons.
➢ Multiply each median found above by an;

𝒌 × 𝟏𝟎𝟎
𝑨𝒅𝒋𝒖𝒔𝒕𝒎𝒆𝒏𝒕 𝑭𝒂𝒄𝒕𝒐𝒓 =
∑ 𝒎𝒆𝒅𝒊𝒂𝒏𝒔

Where k is the number of seasons. Median “is the middle of

a sorted list of numbers”

The calculation of the quarterly seasonal indices for the sales

data is done in the following way:

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Example:

Period Sales(𝑦) 4-Quarter MA Centred MA Seasonal ratios

𝐶𝑜𝑙𝑢𝑚𝑛(1)
=
𝐶𝑜𝑙𝑢𝑚𝑛(3)
(1) (2) (3) (4)
𝑄1 10
𝑄2 8 11.0
𝑄3 12 10.5 10.75 111.63
𝑄4 14 12.5 11.5 121.74
𝑄1 8 14.25 13.375 59.81
𝑄2 16 14.5 14.375 111.30
𝑄3 19 15.5 15.0 126.67
𝑄4 15 16.0 15.75 96.77
𝑄1 12 15.0 15.5 77.42
𝑄2 18 14.5 14.75 122.03
𝑄3 15
𝑄4 13

Averaging seasonal ratios:

𝑄1 𝑄2 𝑄3 𝑄4
Year1 - - 111.63 121.74
Year2 59.81 111.30 126.67 96.77
Year3 77.42 122.03 - -
Median Seasonal Index 68.615 116.665 119.15 109.225
∑ 𝒎𝒆𝒅𝒊𝒂𝒏 = 𝟔𝟖. 𝟔𝟏𝟓 + 𝟏𝟏𝟔. 𝟔𝟔𝟓 + 𝟏𝟏𝟗. 𝟏𝟓 + 𝟏𝟎𝟗. 𝟐𝟐𝟓 = 𝟒𝟏𝟑. 𝟔𝟖𝟓

Compute adjusted seasonal indices

𝟒𝟎𝟎
Adjustment factor: = 𝟎. 𝟗𝟔𝟕
𝟒𝟏𝟑.𝟔𝟖𝟓

Median Seasonal Adjustment factor Adjustment

index Seasonal index
𝑄1 68.615 × 0.967 =66.35
𝑄2 116.665 × 0.967 =112.82
𝑄3 119.15 × 0.967 =115.22
𝑄4 109.225 × 0.967 =105.62
Total = 400

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6.7. Forecasting Future Values
If it can be assumed that the effects of the cyclical and irreg-
ular component are small, then forecasts can be found in follow-
ing way:
➢ Calculate the trend values (using the trend line equation)
for the required future periods.
➢ Seasonal the trend values calculate in above step

𝑺𝒆𝒂𝒔𝒐𝒏𝒂𝒍 𝒊𝒏𝒅𝒆𝒙
𝑭𝒐𝒓𝒆𝒄𝒂𝒔𝒕 = 𝒔𝒆𝒂𝒔𝒐𝒏𝒂𝒍𝒊𝒛𝒆𝒅 𝒗𝒂𝒍𝒖𝒆 = 𝒕𝒓𝒆𝒏𝒅 ×
𝟏𝟎𝟎
Example: Suppose that the quantify forecasts are needed for
Year4 for the sales

Trend values:
40 38 554
Year4: 𝑄1 : 𝑦= + (13) =
3 143 33
40 38 7430
𝑄2 : 𝑦= + (15) =
3 143 429
40 38 7658
𝑄3 : 𝑦= + (17) =
3 143 429
40 38 7886
𝑄4 : 𝑦= + (19) =
3 143 429

Forecasts:
554 66.35
Year4: 𝑄1 : × = 11.14
33 100
7430 112.82
𝑄2 : × = 19.54
429 100
7658 115.22
𝑄3 : × = 20.57
429 100
7886 10562
𝑄4 : × = 19.42
429 100

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Tutorial 9

1. The product manager of a paper mill has accumulated the

following information on quarterly production (in millions
of rand):
Quarter 1 2 3 4
Year

1989 2.6 3.1 4.8 3.2

1999 2.9 4.5 5.0 3.4
1991 2.8 4.9 5.5 3.3
1992 3.1 5.1 5.6 3.6
1993 3.4 5.2 6.0 3.9

a) Plot the data

b) Calculate the equation of the least squares trend and
draw this line on the graph (a).
c) Calculate the seasonal indices
d) Forecast the production for each quarter of 1994.

2. Consider the sales of product for two successive years.

Year 1 Year 2
𝑸𝟏 𝑸 𝟐 𝑸𝟑 𝑸 𝟒 𝑸𝟏 𝑸 𝟐 𝑸𝟑 𝑸 𝟒
10 8 12 14 8 16 19 15

a) Calculate the equation of the least squares trend

b) Calculate the seasonal indices
c) Forecast the production for each quarter of Year3.

The End!!!!!!!!!!! GOODLUCK ON YOUR EXAMS!!!!!!!!!!!!!!

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