Question

(a) Consumer durables, such as washing machines, are part of the capital stockbut do not generate any financial income for their owners. Why do we include consumer durables in the capital stock? (b) To wash your clothes you can take them to a launderette and spend \(£ 2\) per week indefinitely or buy a washing machine for \(£ 400\). It costs \(£ 1\) per week (including depreciation) to run a washing machine, and the interest rate is 10 per cent per annum. Does it make sense to buy the washing machine? Does this help you answer part (a)?

Short answer

It makes sense to buy the washing machine as it saves money annually; consumer durables are capital stock because they provide long-term utility, as seen in this example.

Step-by-step solution

Understanding Consumer Durables as Capital Stock

Consumer durables, like washing machines, are considered part of capital stock because they provide utility over a period of time, similar to how actual capital goods contribute to productive processes. They hold value and contribute to a household's ability by providing services albeit not generating direct income.

Calculate the Total Cost of the Launderette

Taking clothes to a launderette costs £2 per week. Over a year, this amounts to:\[2 \text{ pounds/week} \times 52 \text{ weeks/year} = 104 \text{ pounds/year}\]

Calculate the Total Cost of Owning a Washing Machine

Buying a washing machine costs £400 initially, plus £1 per week operating cost. The operation cost for a year would be:\[1 \text{ pound/week} \times 52 \text{ weeks/year} = 52 \text{ pounds/year}\]Adding the 10% interest on £400, the yearly interest cost is:\[400 \times 0.10 = 40 \text{ pounds/year}\]So, the total annual cost of owning the washing machine, including interest, is:\[52 + 40 = 92 \text{ pounds/year}\]

Compare Costs and Make a Decision

Comparing the costs: - Launderette: £104 per year - Washing Machine: £92 per year Since £92 is less than £104, it makes financial sense to buy the washing machine.

Relating the Decision to Part (a)

Buying the washing machine enables you to save money over the launderette service. This utility without generating financial income aligns with how consumer durables function as capital stock—they provide economic benefit through cost savings and utility rather than direct financial revenue.

Key concepts

Capital Stock

In economics, capital stock refers to the total value of capital assets that are used for productive activities in an economy. It's an essential component for producing goods and services. Consumer durables, such as washing machines, are part of this category, even though they do not directly create financial income. They are included because they provide significant utility over time by fulfilling essential functions that enhance daily living. For example, a washing machine facilitates easy laundry care, saving time and providing convenience. Although it doesn't generate revenue, it offers valuable services similar to how businesses use machinery to increase efficiency.

Utility

Utility is an economic term that refers to the satisfaction or benefit derived from consuming goods and services. It reflects the degree of needs and wants fulfillment. In the context of consumer durables like washing machines, utility is the principal reason these items are valued. They provide ongoing assistance in everyday tasks without requiring a repetitive expense. In the example exercise, the utility is evident in the savings and efficiency gains attained from having a personal washing machine at home, as opposed to using a launderette weekly. This continuous contribution to well-being makes consumer durables a valuable part of capital stock.

Interest Rate

The interest rate is a critical factor when assessing whether to make a significant purchase like a washing machine. It represents the cost of borrowing funds or the reward for saving money. In the exercise given, a 10% interest rate is applied to the initial buying price of the washing machine, affecting your total annual cost. This rate helps determine how much it would cost to finance the purchase if necessary. Understanding interest rates enables consumers to compare the long-term benefits of buying durable goods with the alternative of making weekly payments for services like launderette use.

Depreciation

Depreciation refers to how an asset loses value over time due to wear and tear or obsolescence. With consumer durables, like washing machines, it's essential to consider depreciation when calculating operating costs. A washing machine may initially cost £400, but its value decreases annually as it experiences regular use. This depreciation is part of the £1 per week running cost mentioned in the exercise. Recognizing the depreciation helps accurately assess the true cost and longevity of consumer durables, allowing for informed financial decisions regarding their purchase management.