Question

Which of the following is not correct about residential investment?

• A. It depends on the net real return obtained by owning housing.
• B. The combination of high nominal interest rates and high inflation strongly encourages housing investment.
• C. The demand for housing is insensitive to the nominal interest rate.
• D. The cost of owning a house rises almost proportionately with the real interest rate.

Hint:

The demand for housing is closely related to the nominal interest rate. Higher interest rates typically reduce the affordability of mortgages, thus reducing housing demand.

Answer 1

The Correct Option is C

Residential investment is largely driven by factors such as the return on housing investments, interest rates, and the cost of ownership. It is a key component of the housing market. - (A) It depends on the net real return obtained by owning housing: This is correct. The net real return (after considering interest rates, inflation, and maintenance costs) plays a significant role in the decision to invest in housing.
- (B) The combination of high nominal interest rates and high inflation strongly encourages housing investment: This is incorrect. High nominal interest rates typically discourage housing investment because they increase the cost of borrowing. While high inflation might increase the nominal return on housing, the combination of these factors tends to reduce housing investment rather than encourage it.
- (C) The demand for housing is insensitive to the nominal interest rate: This is incorrect. The demand for housing is sensitive to nominal interest rates. Higher interest rates increase the cost of mortgages, which reduces housing demand.
- (D) The cost of owning a house rises almost proportionately with the real interest rate: This is correct. Higher real interest rates generally increase the cost of owning a home, as mortgage payments rise in response to higher interest rates.
The correct answer is (C) because the demand for housing is highly sensitive to changes in nominal interest rates. An increase in interest rates typically reduces demand for housing due to higher mortgage costs. Final Answer: (C) The demand for housing is insensitive to the nominal interest rate.