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John and Alice are trying to decide whether to purchase a new house

Economics

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John and Alice are

trying to decide whether to purchase a new house. The house they want to

purchase is priced at $2

5

0,000. Annual expenses such as maintenance, taxes, and insurance

equal 4% of the house’s value. If property maintained, the house’s real value is not expecte

d to

change. The real interest rate in the market is 6%, and John and Alice can qualify to borrow

the full amount of the purchase price (assume no down payment) at that rate. Ignore the fact

that mortgage interest payments are tax

-

deductible in Australia.

a)

John and Alice would be willing to pay $1,

8

00 monthly rent to live in a house of the same

quality as the one they are thinking to purchase. Should they buy the house?

b)

Does the answer to part a change if they are willing to pay $2,

5

00 monthly rent?

c)

Does the

answer to part a change if the real interest

rate is 4% instead of 6%?