Question

Joe is an analyst who specializes in the market for lumber. The Federal Reserve move to increase interest rates has caused considerable slowdown in the housing industry due to rising mortgage costs. One immediate impact is that there has been a decrease in the demand for lumber. Joe has determined that there has been no impact on the supply curve. Finally, suppose Joe has verified that the domestic lumber industry satisfies all the conditions of a perfectly competitive market, and Joe has verified that this industry is a “constant cost” industry, a term economists use to indicate that the costs of firm X are not changed by either exit or entry on the part of any other firm.

Question 1

Suppose that prior to the Federal Reserve interest rate intervention, the lumber industry was in long run equilibrium at price P_{0}P0​and quantity Q_{0}Q0​ as shown in the graph below.

Starting with the graph given, show the impact of the interest rate intervention on short run price and quantity in the market for lumber. Be sure to indicate all key values.

Question 2A

Joe’s boss understands the short run impact on lumber but is more interested in the long run price and quantity. Recalling that lumber is a perfectly competitive industry, use the same graph to show what happens as we move from the short run in Question 1 to the long run here.

Indicate the long run equilibrium price and quantity in this market.

Upload the image of your graph.

Answer 1

Question number 1 is answered for you.

The equilibrium price prior to Fed�s interest rate invertion was OP_0 and equilibrium quantity was OQ_0. Now since fed has increased the interest rater, the loans have become more costlier and hence people refrain themselves from taking loan. As a result the demand for lumber has gone down. This will be shown through a leftward shift in demand curve Delta_0 to Delta_1 As a result, since the supply is the same, the new equilibrium price went down to OP_1 and equilibrium quantity reduced to OQ_1