Question from Past Microeconomics Qualifying ExamEdit
Fall 2005 - Section I, Question five, George Mason University
T, F, U. State first whether the following statements are true, false or uncertain. Then briefly explain your reasoning in four or five sentences. You may use a graph if it helps clarify your answer.
A sudden increase in interest rates should lower the price of lumber in the short run.
Applied Answer: An increase in interest rates implies a shift of consumption from current consumption to future consumption. It furthermore will lower the amount of investment in an economy. Both of these results imply a lower demand for lumber, which is considered to be an input into construction etc., which should lead to a decrease in lumber prices.
Alternative: The higher interest rates signals present orientedness. Scarcity of lumber from current use drives the price of lumber up as more resources are prematurely pulled off the future market to meet current demand. (Much like Alchian and Allen from WEW's class p. 123 in Exchange and Production)
True: The higher interest rate will make it more costly to let tree grow older, leading loggers to cut the trees, and the supply of lumber increases, driving the price of lumber down. Alos, the higher interst rates will reduce the demand for housing, reducing the deman for lumber and further reducing the price of lumber.
- Alchian, A. and Allen, W. : Exchange and Production: Competition Coordination and Control Wadsworth 1983