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Chapter 28: Problem 13

(Related to the Chapter Opener on page 994) In its 2016 Annual Report, Toll Brothers noted, "If mortgage interest rates increase significantly ... our revenues, gross margins, and net income could be adversely affected." a. Why might an increase in mortgage interest rates reduce revenue and profit for Toll Brothers? b. During this period, was Fed policy attempting to reach a point on the short-run Phillips curve representing higher unemployment and lower inflation or a point representing higher inflation and lower unemployment? Briefly explain. c. What connection is there between Fed policy and Toll Brothers' concern about the effect of rising mortgage interest rates on its profit?

Short Answer

Expert verified
An increase in mortgage rates might reduce the demand for homes, impacting Toll Brothers' revenue and profit. The Fed's policy during the period isn't specified, but they could have been trying to control either inflation or employment stability. If the Fed's policy led to higher interest rates, it would directly impact Toll Brothers' business by potentially decreasing the demand for homes.

Step by step solution

01

Identify the impact of mortgage interest rates on Revenue and Profit

If mortgage interest rates increase, it makes it more expensive for people to borrow money to buy homes. As a result, demand for buying homes might decrease, leading to a reduction in Toll Brothers' revenue. Since the cost of production and operation might remain the same or increase, with decreased revenue, the profit margin might also shrink.
02

Explore Fed's Policy

The Federal Reserve's policy during the period isn't explicitly mentioned in the exercise. However, if we assume the Fed was attempting to control inflation and retain employment stability, two scenarios are possible. If the Fed aimed for higher unemployment and lower inflation, they would likely raise interest rates to control inflation. If their target was higher inflation and lower unemployment, they would reduce interest rates to stimulate economic growth.
03

Establish the connection between Fed's policy and Toll Brothers' concern

The Federal Reserve can influence mortgage rates through its policy. If they raise interest rates to control inflation, mortgage rates might also increase. This is a concern for Toll Brothers because, as identified in step 1, increased costs of borrowing can reduce demand for homes, affecting their revenue and profit margin.

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Most popular questions from this chapter

Why did Milton Friedman argue that the Phillips curve did not represent a permanent trade-off between unemployment and inflation? In your answer, be sure to explain what Friedman meant by the "natural rate of unemployment."

A 2017 column in the Wall Street Journal noted that "longterm consumer inflation expectations [are] at record lows." If inflation turns out to be higher than households and firms had previously expected, will the actual real wage end up being higher or lower than the expected real wage? Will employment in the short run end up being higher or lower? Briefly explain.

What does it mean to say that workers and firms have rational expectations?

A column in the New York Times in 2017 was titled "The Low-Inflation World May Be Sticking Around Longer Than Expected." Are the low inflation rates of recent years entirely the result of Federal Reserve policy? Could they have occurred without the Fed having a mandate to achieve price stability? Briefly explain.

An opinion column in the Wall Street Journal noted, "In a democracy, the tradeoff for a central bank's independence is accountability to the nation's elected leadership." a. Why would a country want to grant its central bank more independence than it grants, say, its department of agriculture or department of education? b. In the United States, how is the Fed held accountable to the nation's elected leadership? Source: David Wessel, "Explaining 'Audit the Fed," Wall Street Journal, February 17, 2015 .
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