Question from Past Microeconomics Qualifying ExamEdit
Fall 1999- Section I, Question one, George Mason University
True, False, Uncertain. Determine whether or not each of the following statements are true or false. Explain your reasoning briefly in a paragraph or two. (The explanation is often more important than the answer given). Include a carefully labeled diagram or game matrix if it helps to clarify your answer.
A decrease in the height of Christmas trees brought to market implies that there has been a decrease in the rate of interest.
- False, If trees are shorter they are being harvested earlier which implies that their future value has decreased relative to the current price. Since current goods are worth relatively more, then trees will be harvested, on average, earlier.
False The simplest version of Hotelling’s rule states that if prices are expected to grow slower that the rate of interest, then owners of resources will immediately extract and sell those resources. If trees are shorter, they are being harvested earlier which implies that their future value has decreased relative to the current price. This condition is indicative of an increase in interest rates, not a decrease. Owners are extracting their resource (trees) now because they can invest the proceeds at a higher rate of interest.
Hotelling’s Rule: If increase in price is less than interest rate (R), extract resource: If increase in price is greater than R, hold the resource for future production/sale