Microeconomics Question from Walter E. Williams:[]
Suppose you were in a country where the charging of interest was prohibited by law. How could you tell whether the present price of future goods changed? What kind of evidence would you look for. Justify your choice of evidence and indicate the direction of the change in the present price of future goods.
Answer[]
You can tell whether the interest rate has changed by observing the relative prices of related goods (grapes and raisins, milk and cheese, etc.) If the price of grapes increases relative to the price of raisins, the interest rate has fallen. The equation is: PV (grapes) = FV (raisins)[1 + r]. If PV increased relative to FV, then r must have gone down. Furthermore, low interest rates encourage investment, which means the supply of grapes would decrease (in favor of raisins) and their price would rise.
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