You are asked to examine the market for luxury housing in the southern Westchester town of Quietville. This kind of housing is said to be a normal good. In Quietville a substantial proportion of the people who buy luxury homes are people who work in the financial sector on Wall Street. With the recent downturn in the stock market, you are told that many people in the financial sector are taking home smaller paychecks. An analyst of the real estate market offers the following prediction:
"As a result of the woes on Wall Street, I believe that the price of luxury homes in Quietville will fall. The Wall Street crowd clearly will buy fewer of these houses. Others people (not employed on Wall Street) who buy these houses will not be affected. Their incomes, after all, have not changed."
On a piece of paper, use a single graph to derive your conclusions about the effects of events on Wall Street and explain your agreement or your disagreement with the statement above. Explain the logic of your answer fully, in clear English.
To examine the market for luxury housing in Quietville, we need to consider the relationship between the price of luxury homes and the quantity demanded of these homes. We will create a graph with the quantity of luxury homes demanded on the x-axis and the price of luxury homes on the y-axis.
First, let's draw a demand curve for luxury homes in Quietville. Since luxury housing is considered a normal good, we expect the demand curve to slope downwards from left to right. This means that as the price of luxury homes decreases, the quantity demanded will increase, and vice versa.
Next, we need to consider the impact of the recent downturn in the stock market. The analyst claims that the price of luxury homes will fall as a result, mainly due to the decrease in purchasing power of people working on Wall Street. According to the analyst, these individuals will buy fewer luxury homes, while others who are not employed on Wall Street will remain unaffected.
Based on this information, we can make an assumption about how the downturn in the stock market will affect the demand for luxury housing. If people working on Wall Street are experiencing smaller paychecks, it is likely that their purchasing power and ability to afford luxury homes will decrease. This would cause a leftward shift in the demand curve, indicating a decrease in quantity demanded at each price level.
However, the analyst assumes that people who are not employed on Wall Street will continue to buy luxury homes unaffected. This assumption implies that the demand curve for luxury homes for non-Wall Street buyers will remain unchanged.
To represent this scenario on the graph, we would shift the demand curve for luxury homes to the left, reflecting the decrease in quantity demanded by Wall Street buyers. The demand curve for non-Wall Street buyers would remain the same.
Now, our graph should show two separate demand curves: one representing Wall Street buyers and the other representing non-Wall Street buyers. The demand curve for Wall Street buyers would be shifted to the left, while the demand curve for non-Wall Street buyers would remain unchanged.
Based on this analysis, it is reasonable to agree with the analyst's prediction that the price of luxury homes in Quietville will fall. However, it's important to note that the extent of this price decrease would depend on the relative importance of Wall Street buyers in the luxury housing market and the elasticity of demand for luxury homes. If the demand from non-Wall Street buyers is significant, it could partially offset the decrease in demand from Wall Street buyers and mitigate the impact on luxury home prices.