Question

You currently pay $10,000 per year in rent to a landlord for a $100,000 house, which you are considering purchasing. You can qualify for a loan of $80,000 at 9% if you put $20,000 down on the house. To raise money for the down payment, you would have to liquidate stock earning you a 15% return. We neglect other concerns, like closing costs, capital gains, and tax consequences of owning.

1. Explain the concept of opportunity cost.

2. Explain the fixed cost and the the hidden cost fallacy.

3. Given the described situation, determine whether it is better to rent or own. Show all your calculations and logical arguments.

Answer 1

1. The opportunity cost refers to the value of only a single best forgone alternative thus is the loss of other alternatives when one alternative is chosen. In the given scenario, the opportunity cost of money paid for house would be the 15%return from investing it

　

2. The fixed-cost fallacy arises when the irrelevant costs are considered. The most common example of fixed-cost fallacies is to considering the influence of depreciation costs on short-run decisions. The hidden-cost fallacy arises when the relevant costs are ignored. The most common example of hidden-cost fallacy is to ignoring of the opportunity cost for capital while making decisions on the shutdown or investment

　

3.

Cost of owning the house:
Qualify for a loan	80,000
Loan interest (9% * 80,000)	7200
Payment for house	20,000
Cost of 20,000 (0.15 * 20,000)	3,000
	110,200
Cost of house	100,000
Total cost of owning the house	10,200
Cost of rented house:	10,000

The above calculations reveal that the better option would be to continue living in the rented house