Interest rates can be defined as the cost of borrowed funds, higher interest rates means that the cost of borrowed funds is high, in the case where we have lower interest rates then the cost of borrowed funds is low. Therefore when interest rates are low then there is more borrowing by the population and at the same time there are higher levels of investment.
In this paper we analyse the construction industry in California and how it is affected by interest rates that prevail in the economy.
The following data shows the number of houses built in California over the years; the data is
retrieved from http://factfinder
2005 or later
2000 to 2004
1990 to 1999
1980 to 1989
1970 to 1979
1960 to 1969
1950 to 1959
1940 to 1949
The following graph shows the number of housing units built over the years in California:
From the diagram above it is clear that the number of houses have increased from the 1940 until it reached a peak in the 1970, from the 1970 to day to the number of houses built has declined over the years.
The graph below shows the level of interest rates in California, the rates were retrieved from htt p://www.harpfinancial.com/InterestRateHistory/PrimeRate.htm
From the above diagram it is clear that interest rates have declines from 1999 until 2004 where interest rates have risen to date, interest rates are the cost of borrowing funds and therefore with the increase in interest rates means that les houses are built or the demand for houses has declined as the cost of funds increase with interest rates.
Keynes theory and interest rates:
Keynes emphasised the importance of the level of interest rates on investment levels, according to Keynes when interest rates were high then the level of cost of funds was high and the level of investment would be low, if interest rates declined then the level of investment would rise, therefore according to Keynes the interest rate investment relationship can be simplified in the following graph.
Classical theory and interest rates:
The classical theorist also recognise the importance of interest rates in the determination of the investment levels, however classical theorist also show the importance of the interest rates as a tool used by the government to fine tune the economy of a country, the interest rates are increased to reduce money supply in the economy in order to avoid inflation.
The housing industry is more at home with the classical theories, classical theorist were referred to as classical theorist because any economic theory developed after them have borrowed a leaf from them, they are also referred to as classical because of their unquestionable explanation of economics and because they brought order into economic enquiry.
The construction industry in California therefore has been affected by interest rates, interest rates affect the level of investment, when the interest rates affect the investment level then they
affect the supply side, further the interest rates also affect the demand side where buyers find it expensive to acquire loans due to high levels of interest rates
Financials (2007) historical interest rates in California, retrieved on 23rd November, available at http://www.harpfinancial.com/InterestRateHistory/PrimeRate.htm
Census government (2007) the construction industry data, retrieved on 23rd November,
available at http://fa ctfinder.census.gov/servlet/ADPTable?_bm=y&-geo_id=04000US06&-qr_name=AC S_2006_EST_G00_DP4&-ds_name=ACS_2006_EST_G00_&-_lang=en&-redo Log=false
Philip Hardwick (2004) Introduction to Modern Economics, Pearson Press, New York
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