Question

A painter is deciding whether to purchase a new paint sprayer. the sprayer costs $500 and has a useful life of just one year. the expected revenue from the sprayer is $540, which means the expected profit is $40. use this information to fill in the table. determine whether or not the painter should purchase the sprayer at the stated interest rate.

interest rate
(percent) buy the sprayer?
10
6

the preceding example demonstrates how the interest rate can allocate resources among different time periods. however, economists have questioned the effectiveness of this mechanism for the efficient allocation of resources in practice.

which of the following are reasons for such doubt?

A. people do not give adequate weight to the future when making economic decisions today.
B. private firms and individuals may underestimate the impact of irreversible decisions.
C. governments frequently manipulate interest rates to affect consumption and investment.

Answer 1

To determine if a painter should buy a $500 paint sprayer with a $40 expected profit, the opportunity cost must be considered. At a 10% interest rate, the painter would be better off financially by not purchasing the sprayer, while at 6% the purchase is justified. However, doubts about the efficiency of interest rates in resource allocation exist due to factors such as human shortsightedness, underestimation of irreversible decisions, and government manipulation.

Step-by-step explanation:

When a painter is considering the purchase of a new paint sprayer that costs $500 with an expected revenue of $540, the expected profit is $40. Assessing whether the painter should buy the sprayer involves comparing the expected profit to the opportunity cost of the investment, represented by the interest rate. If the painter can earn a higher return on an alternative investment at a given interest rate, it may not be worth buying the sprayer. For example, an interest rate of 10% would mean that investing the same $500 elsewhere could potentially yield $50 in interest, exceeding the $40 profit from the sprayer. However, at an interest rate of 6%, the same investment would yield only $30, making the sprayer purchase more attractive.

Economists have raised concerns about the effectiveness of interest rates in allocating resources efficiently. The reasons for doubt include: A. people not giving adequate weight to the future when making economic decisions today, B. private firms and individuals possibly underestimating the impact of irreversible decisions, and C. governments often manipulating interest rates to affect consumption and investment. These factors can impede the ideal function of interest rates in resource allocation.

If we are to consider a financial investor who decides that the appropriate interest rate to value future payments is 15%, then any investment with a return less than this rate would likely be rejected. When applying this to the painter's scenario, if the expected profit from the sprayer translates to a return less than 15%, the new paint sprayer would not be a worthwhile investment at this rate.