According to a paper on financial literacy, only 7% of the American people answer this question correctly:
You purchase an appliance which costs $1,000. To pay for this appliance, you are given the following two options: a) Pay 12 monthly installments of $100 each; b) Borrow at a 20% annual interest rate and pay back $1,200 a year from now. Which is the more advantageous offer?
(i) Option (a);
(ii) Option (b);
(iii) They are the same;
(iv) Do not know;
(v) Prefer not to answer.
Source: Felix Salmon, who argues the correct answer may not be the most appropriate choice.
Answer in comment.
The correct answer to the financial literacy question is:
Answer ii, Option (b). Option (a) is an APR of 35%. Option (b) is 20%. The time value of money, blah, blah, etc.
Salmon wonders whether for most people having to make this choice however, Option (a), equal monthly payments, might not be the better way to buy an appliance. But I guess we all should know enough to realize that answer ii is financially advantageous.
Guess I’m too dumb to buy a refrigerator, because I looked at the answers and couldn’t choose between the two wrong ways listed.
Who the hell spends a thousand dollars they don’t already have in hand on a fridge?
If you can’t afford to pay for it, buy a smaller or older one.
How much money will $1000 earn in a year? Especially if it is accumulated on a monthly basis. The real world flaw here is that people will save up for the “loan burning”.
For most irrational (normal) humans, (i) is best, as Salmon says.
Seems to me that arguing “i” is correct fails the very premise of the question.
The question is: which option “i” or “ii” would the financially literate consumer choose. The answer, of course, is “ii” because consumer is assumed to be literate. To argue “i” is correct because the consumer may be too illiterate to understand that you can’t spend the 100/month of the intervening months, contradicts the original question of what would a financially literate consumer do.
If you are financially literate, you don’t act financially illiterate!
Felix Salmon discusses the question and its choices.
I would go to Craigslist and spend $300 cash on one someone else bought a couple years ago for $1000. (People move or remodel and sell totally reliable, nearly new appliances all the time.) It’s part of the “low-carbon footprint, reuse, recycle” philosophy, and it saves bundles of money.