The rate of interest, or the rate at which people discount the future, depends upon the characteristics of different individuals as well as upon the size and character of their incomes. Persons who have much foresight and strong self-control, who are accustomed to live modestly and who expect to live to a ripe old age, who have a family in whose welfare they are interested, - such persons are inclined to discount the future at a low rate. They tend to make the rate of interest low. On the other hand, persons who are short-sighted, weak-willed, accustomed to spend freely, uncertain of life and selfish, discount the future at a high rate. They tend to raise the rate of interest. The rate of interest is a composite of the rates of discount of all of the people who borrow and lend.

The different individuals' rates of discount of the future depend not alone upon the characters of the individuals but upon the characters of their incomes as well. If the income promises to increase rapidly in the future, its owner will tend to have a high discount rate, other things being equal. On the other hand, a declining income tends to produce a low discount rate. The larger the income, other things being equal, the lower will be the discount rate. If one's income is extremely small, he will discount the future at a high rate; a smaller amount of goods available for his use to-day he will consider equivalent to a much larger amount of goods available for use next year; whereas if an income is very large, its owner will discount the future at a low rate.

The rate of discounting the future, then, changes as the amount of income changes. This fact is extremely important in fixing the standard rate of interest. For example, let us take as representatives of all persons the five persons, A, B, C, D, and E. Let us say that with A's character what it is, and his present supply of goods what it is relatively to the future, he does not wish to discount the future at all. He considers a hundred dollars a year from to-day as desirable as a hundred dollars to-day. Let us say that in the cases of B, C, D, and E, the rate of discounting the future is such that a hundred dollars now is considered equivalent to a hundred and three dollars, a hundred and five dollars, a hundred and six dollars, and a hundred and ten dollars, respectively, a year from now. It is a matter of indifference to A, as we have seen, whether he has a hundred dollars to-day or a hundred dollars a year from now, but E is very anxious to have his hundred dollars to-day. Therefore, A gives to E a hundred dollars of his income with the understanding that a year from now E will give to A in return an equivalent part of his income. If necessary, E is willing to give a hundred and ten dollars of his next year's income for a hundred dollars to-day. Just what rate of interest E will pay A will depend upon their relative bargaining power and the condition of the loan market. But after A has given E one hundred dollars of this year's income and has by this means added one hundred dollars to his own next year's income, his rate of discounting the future undergoes a change because his next year's income is relatively higher as compared with his this year's income. A now has a preference for to-day's income as compared with next year's income. Let us represent this preference by one per cent. In other words, A now considers that a hundred dollars to-day is worth a hundred and one dollars a year from now. On the other hand, E has increased his present income relatively to his future income and has therefore decreased his rate of discounting the future. Let us say that he decreased it one per cent, or, in other words, that he now considers a hundred dollars to-day equivalent not to a hundred and ten dollars a year from now as formerly, but to one hundred and nine dollars a year from now.

D is also very anxious to have an increased income to-day in exchange for some of next year's income. His anxiety is represented by a discounting of the future at the rate of six per cent per annum. B, on the other hand, discounts the future at the low rate of three per cent per annum. Suppose, now, that B lets D have one hundred dollars to-day in return for a hundred and six dollars a year from now. This will change the discount rates of both B and D. Let us say that it changes them one per cent and that B now considers a hundred dollars to-day equivalent to a hundred and four dollars a year from now, and D considers a hundred dollars to-day equivalent to a hundred and five dollars a year from now. This practice of loaning will continue, and those who discount the future at a low rate will lend to those who discount it at a high rate, and both the lenders and the borrowers will continue to change the amount of their present income in its relation to their future income until they all arrive at the same rate of discount for the future. This will be the market rate of interest.