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Chapter 4: Problem 8

Every year, the housing market in Monotone, Arizona, has the same experience: The demand curve for housing shifts rightward by 500 homes, 500 new homes are built, and the price of the average home doesn't change. Using supply and demand diagrams, illustrate how each of the following new events, ceteris paribus, would affect the price of homes in Monotone during the current year, and state whether the price rises or falls. a. Because of special tax breaks offered to Monotone home builders, 800 new housing units are built during the current year. b. Because of events in the overall economy, interest rates fall. c. The Monotone city council passes a new zoning law that prevents any new home construction in Monotone during the year. d. Because of the new zoning law, and the resulting change in home prices, people begin to think that homes in Monotone are a better investment than they had thought before. e. 500 new homes are built in Monotone during the year, but that same year, an earthquake destroys 2,000 preexisting homes. As a result of the earthquake, 3,000 homeowners decide they no longer want to live or own homes in Monotone.

Short Answer

Expert verified
a. The price of the houses falls because of increased supply. b. The price rises due to increased demand. c. The price rises due to supply remaining constant while demand increases. d. The price rises due to increased demand. e. The price of homes will either fall or rise, depending on whether the decrease in demand is greater or less than the decrease in supply.

Step by step solution

01

Case a - Tax Breaks Resulting in Extra House Construction

The special tax breaks results in an increase in the supply of housing units from 500 to 800.This shift in supply would result in an excess supply of 300 homes in the market. Because the quantity supplied exceeds the quantity demanded, the price of homes is expected to fall.
02

Case b - Fall in Interest Rates

A fall in interest rates reduces the cost of borrowing, encouraging more people to buy homes, which increases the demand for homes. This rightward shift in the demand curve would lead to an excess demand, thereby leading to a rise in the price of homes.
03

Case c - New Zoning Law Preventing New Home Construction

If no new houses are built during the year, the supply of houses remains constant while the demand for houses increases. This would lead to an excess demand for houses in the market, which would result in a rise in the price of homes.
04

Case d - Perception of Homes as a Better Investment

The increase in the price of homes due to the impact of zoning law leads to the perception that homes are a better investment. This causes an additional increase in demand for homes beyond the annual usual increase of 500. This would further drive up the price of homes.
05

Case e - Earthquake Destroys Preexisting Homes

The earthquake destruction results in a dramatic decrease in the supply of homes, while 3000 homeowners deciding not to live or own homes in Monotone represents a decrease in the demand for homes. If the decrease in demand is greater than the decrease in supply, the price of homes will fall. Otherwise, if the decrease in supply is greater than the decrease in demand, the price of homes will rise.

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