Home mortgage loans and
new homes are complementary goods. Interest rates fell beginning in the fall of
2001 and stayed at historically low levels for several years. Using the supply
and demand model, discuss how falling interest rates affect the equilibrium
price and quantity of the new home market.
Your Answer:
Falling interest rates
cause the monthly payments for a new home to fall, all else remaining equal,
which makes the purchase of a new home more affordable.
As the interest rate
and monthly mortgage payments fall, the demand for new homes increases, since
mortgages and new homes are complementary products. The increase in demand for
new homes is illustrated by a right shift in the demand curve.
All else
remaining equal, the equilibrium price and quantity of new homes will rise when
interest rates fall.
Source: Pindyck /
Rubinfeld, Microeconomics, 7th edition, Pearson
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