Using Economy Theory to Answer Few Important Questions in Life 1

I plan to write this in a while but i now currently packed with tonnes of work on my shoulder. However recently i went to watch "Wall Street Money Never Sleep" and inspired by it to give my opinion of basic questions in our life using economic theory.

Lot of people think that economic theory is plainly theory and can't be applied in real world (although economist always prove a hypothesis using empirical study). My response to them are simple: they do not understand economics well and they do not understand economy in general.

Currently I am lecturing on the subject of Economics in a business school and the student can't see the reason why they need to learn economic. In their world, Business is everything and they think business subjects such as marketing, human resource management and logistic management are much more important than economics.

Well are they?

Recently I did a simple research on the correlation between the management quality and profit. To my surprise, no matter how I manipulate the data, the best correlation I get is +0.17. In other word, Management quality only 17% related to the profit of a firm. So where are the rest (83%)?

Predictably economy factor (GDP) has a correlation of +0.79 to the profit of firms.

It means no matter hard good is the management quality of a firm, Economy factors(such as GDP and inflation rate) are the dominant factor in determining the profit of a firm.

Back to our topic, I plan to give my opinion of basic questions in our life using economic theory. This is based on my knowledge in economics (hopefully enough lol) and experience in the financial markets. Note that the answer i give may vary according to the demographic and economic environment.

The first question i want to discuss is this: should you buy or rent a house?

Many people will immediately say we should buy. In fact many websites including Yahoo Finance have their analysis on the topic and conclude that you should own house(s).

However, is that true?

I will answer the question according to the variables in my country. However you can all apply the analysis in your own country perspective.

Let say we use a simple example as our focus of analysis. The price of an expensive house (300 square meter) in my area is around $ 750,600 and the average rent in that type of houses is $ 3,657

So which is better, buy or rent?

So we will calculate the monthly cost of each option and determine which is better option.

If I buy:

Interest cost (The base lending rate in commercial banks in my country is 5.75% p.a. and they will usually charge BLR + 1 to 5% depend on their evaluation. The normal mortgage rate is BLR + 2% which is 7.75% p.a.)

= (750,600 x 7.75%) / 12
= $4,847.625 or $ 4847.63 per month

Property Assessment tax

= (3657 x 12 months) x 4.5%
= 43884 x 4.5%
= $1974.78

Opportunity cost. Since you used your money to buy house (and forfeit the opportunity of investing in other financial instruments), opportunity cost occurred. Let say we use average 30 years T-bill rate for the last 5 years.

Average 30 years t-bill rate (last 5 year) = 5.32%

(750,600 x 5.32%) / 12 months
= $ 3327.66

Monthly cost of buying a house (not including principles) = 4847.63 + 1974.78 + 3327.66

= $ 10150.07 per month which is much higher than renting a house (average = $ 3,657 per month)


Furthermore there many costs and risks involved when you own a house. Tenant do not have to bear the cost of maintaining the house while landlord have to bear all the expenses involved.

Besides that, house owner need to bear risk of uncertainty (natural disaster etc) as well.

In conclusion, the theory is simple: if the marginal cost of renting a house vs lower than the marginal cost of buying a house, RENT IT.

Using our example, we should rent.