Understanding Exponential Functions and Compound Interest in Mathematics

1. Chapter 4.2 Exponential Functions

2. Exponents and Properties Recall the definition of ar, where r is a rational number: then for appropriate values of m and n,

3. For example,

4. For example,

5. For example,

10. Exponential Functions We can now define a function f(x) = ex whose domain is the set of all real numbers.

11. Note: If a = 1, the function becomes the constant function defined by f(x) = 1, not an exponential function.

12. In the graph of f(x) = 2x the y-intercept is y = 20 = 1.

13. Since 2x > 0 for all x and the x-axis is a horizontal asymptote.

14. As the graph suggests, the domain of the function is and the range is

15. The function is increasing on the entire domain, and therefore is one-to-one. Our generalizations from the figure lead to the following generalizations about the graphs of exponential functions.

18. Starting with f(x) = 2x and replacing x with –x gives

19. For this reason, the graphs of and are reflections of each across the y-axis. This is supported by the graphs in the figures.

20. The graph of f(x) = 2x is typical of graphs of f(x) = ax where a>1. For larger values of a, the graphs rise more steeply, but the general shape is similar to the graph in the figure.

21. When 0 < a< 1, the graph in a maner similar to the graph of the figure.

24. y x

25. y x

26. y x

27. y x

31. Compound Interest The formula for compound interest (interest paid on both principal and interest) is an important application of exponential functions.

32. Compound Interest Recall the formula for simple interest, I = Prt. where P is principal (amount deposited), r is the annual rate of interest expressed as a decimal, and t is time in years that the principal earns interest.

33. Compound Interest Suppose t = 1 year. Then at the end of the year the amount has grown to P + Pr = P (1 + r) the original principal plus interest.

34. Compound Interest If this balance earns interest at the same interest rate for another year, the balance at the end of that year will be [P(1+ r)] + [P(1+ r)] r = [P(1+ r)] (1+ r) = P (1+ r)2

35. Compound Interest After the third year, this will grow to be Amount = P (1+ r)3 Continuing in this way produces the formula A = P(1 + r)r

37. Suppose $1000 is deposited in an account paying 4% interest per year compounded quarterly (four times per year). Find the amount in the account after 10 years with no withdrawals.

38. How much interest is earned over the 10-year period?

39. Becky Anderson must pay a lump sum of $6000 in 5 years. What amount deposited today at 3.1% compounded annually will grow to $6000 in 5 years?

40. If only $5000 is available to deposit now, what annual interest rate is necessary for the money to increase to $6000 in 5 years?

41. The Number e and Continuous Compounding The more often interest is compounded within a given time period, the more interest will be earned. Surprisingly, however, there is a limit on the amount of interest, no matter how often it is compounded.

42. The Number e and Continuous Compounding To see this, suppose that $1 is invested at 100% interest per year, compounded m times per year. Then the interest rate (in decimal form) is 1.00 and the interest rate per period is 1/m.

43. The Number e and Continuous Compounding According to the formula (with P = 1), the compound amount at the end of 1 year will be

44. The Number e and Continuous Compounding A calculator gives the results in the table for the following values of m.

45. The Number e and Continuous Compounding The table suggests that as m increases, the value of gets closer and closer to some fixed number. This is indeed the case. The fixed number is called e.

46. The figure shows he functions defined by y = 2x , y = 3x ,y = ex. Notice that because 2 < e < 3 , the graph of y = ex lies “between” the other two graphs.

47. As mentioned above, the amount of interest increases with the frequency of compounding, but the value of the expression approaches e as m gets larger.

48. Consequently the formula for compound interest approaches a limit as well, called the compound amount from continuous compounding.

50. Suppose $5000 is deposited in account paying 3% interest compounded continuously for 5 years. Find the total amount on deposit at the end of 5 years.