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Chapter 23: Problem 6

An article in the Wall Street Journal on the housing market stated, "Steady job growth, rising wages and low interest rates have helped prop up housing demand." Why do low interest rates increase the demand for housing? In which component of aggregate expenditure does the Bureau of Economic Analysis include purchases of new houses?

Short Answer

Expert verified
Low interest rates increase the demand for housing because they decrease the cost of borrowing and increase the buying power of individuals, thereby boosting the demand. The Bureau of Economic Analysis includes the purchases of new houses in the 'Investment' component of the aggregate expenditure.

Step by step solution

01

Understanding the role of interest rates in housing market

In any economy, the interest rate plays a crucial role because it determines the cost of borrowing. When interest rates are low, the cost of borrowing for individuals, including mortgages, decreases. This means more people can afford to take loans and this results in increased demand for housing.
02

Impact on demand

Low interest rates have a twofold impact on increasing demand for housing. Firstly, as it becomes cheaper to borrow, buying power increases and more people can afford to purchase houses. Secondly, low interest rates also mean that it is less lucrative to save money as the return on the savings is less. This further encourages spending as opposed to saving and thus fuels demand for sectors like housing.
03

Inclusion in aggregate expenditure

The Bureau of Economic Analysis (BEA) measures the economic activity of a country by using aggregate expenditure which includes consumption, investment, government spending, and net exports. Purchase of new houses falls in the investment component, as investment represents spending on capital goods which includes new residential construction.

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Most popular questions from this chapter

Unemployed workers receive unemployment insurance payments from the government. Does the existence of unemployment insurance make it likely that consumption will fluctuate more or less over the business cycle than it would in the absence of unemployment insurance? Briefly explain.

(Related to the Chapter Opener on page 776) An article in the Wall Street Journal on changes in Intel's sales noted, "Intel sells its chips to customers in U.S. dollars, but many \(\mathrm{PC}\) makers that buy those chips sell their products in local currencies." In these circumstances, would an increase in the value of the dollar relative to foreign currencies be likely to help or hurt Intel's sales? Briefly explain.

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