Well, I always disable that option but I understand why its enabled by default. As others have said, non-techies don't really care about files and they don't want to care. They do care about the "report for the boss", or the "invoice for customer x", or the "budget for 2013". And those were the names they typed when they saved their work, so suddendly the "report for the boss" becoming "report for the boss.docx" or "budget for 2013" becoming "budget for 2013.xlsx" *can* be confusing. Also, your average user never starts an application from anywhere but either the start menu (and that's the reason taking it away in Windows 8 is such a big problem) or a shortcut in the desktop or the taskbar. Or, and this happens a lot, from one of the many actual files they keep on the desktop. So they never *ever* have to tell "excel.exe" from "excel.exe.manifest", and even if they did, "excel" (as it shows when the extensions are hidden) would have an icon they associate with, well, Excel, and "excel.exe" would not. Not confusing at all.
Quidquid latine dictum sit, altum viditur.