Exponential growth and decay (Part 8): Paying off credit-card debt via recurrence relations

The following problem in differential equations has a very practical application for anyone who has either (1) taken out a loan to buy a house or a car or (2) is trying to pay off credit card debt. To my surprise, most math majors haven’t thought through the obvious applications of exponential functions as a means of engaging their future students, even though it is directly pertinent to their lives (both the students’ and the teachers’).

You have a balance of $2,000 on your credit card. Interest is compounded continuously with a rate of growth of 25% per year. If you pay the minimum amount of $50 per month (or $600 per year), how long will it take for the balance to be paid?

In previous posts, I approached this problem using differential equations. There’s another way to approach this problem that avoids using calculus that, hypothetically, is within the grasp of talented Precalculus students. Instead of treating this problem as a differential equation, we instead treat it as a first-order difference equation (also called a recurrence relation):

A_{n+1} = r A_n - k

The idea is that the amount owed is multiplied by a factor r (which is greater than 1), and from this product the amount paid is deducted. With this approach — and unlike the approach using calculus — the payment period would be each month and not per year. Therefore, we can write

A_{n+1} = \displaystyle \left( 1 + \frac{0.25}{12} \right) A_n - 50

Notice that the meaning of the 25% has changed somewhat… it’s no longer the relative rate of growth, as the 25% has been equally divided for the 12 months. The solution of this difference equation is

A_n = r^n P - k \left( \displaystyle \frac{1 - r^n}{1-r} \right)

green line

A great advantage of using a difference equation to solve this problem is that the solution can be easily checked with a simple spreadsheet. (Indeed, pedagogically, I would recommend showing a spreadsheet like this before doing any of the calculations of the previous few posts, so that students can begin to wrap their heads around the notion of a difference equation before the solution is presented.)

To start the spreadsheet, I wrote “Step” in Cell A1 and “Amount” in Cell B1. Then I entered the initial conditions: 0 in Cell A2 and 2000 in Cell B2. (In the screenshot below, I changed the format of column B to show dollars and cents.) Next, I entered =\hbox{A2}+1 in Cell A3 and

=\hbox{B2}*(1+0.25/12)-50

in Cell B3. Finally, I copied the pattern in Cells A3 and B3 downward. Here’s the result:

creditcardexcel1After the formula the algebraic solution of the difference equation has been found, this can be added to the spreadsheet in a different column. For example, I added the header “Predicted Amount” in Cell D1. In Cell D2, I typed the formula

=2000*\hbox{POWER}(1+0.25/12,\hbox{A2})-50*(1-\hbox{POWER}(1+0.25/12,\hbox{A2}))/(1-(1+0.25/12))

Finally, I copied this pattern down the Column D. Here’s the result:

creditcardexcel2Invariably, when I perform a demonstration like this in class, I elicit a reaction of “Whoa…. it actually works!” Even for a class of math majors. Naturally, I tease them about this… they didn’t believe me when I used algebra, but now it has to be true because the computer says so.

Here’s the spreadsheet that I used to make the above pictures: CreditCardDebt.

 

 

 

 

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  1. Exponential growth and decay: Index | Mean Green Math

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