ECON90034 Chap.1 Markets, Efficiency and the Home Loan Market
Markets, Efficiency and the Home Loan Market
The opening weeks review the microeconomics the rest of the subject builds on and apply it straight away to home loans. Opportunity cost, sunk cost and the comparison of marginal benefit with marginal cost frame every later decision. The supply and demand model, with the distinction between a shift of a curve and a movement along it, supports the comparative statics questions that appear in short-answer form.
The home loan tutorial then adds two groups of borrowers with different demands, a perfectly competitive market in which the loan rate equals the deposit rate, and a government ceiling on rates that forces banks to ration loans. You measure consumer surplus for each group, the surplus of lenders and the deadweight loss, and the review lecture lists every one of these items.
A second tutorial problem treats the exchange rate between the Australian and the US dollar as a price set by supply and demand.
What this chapter covers
- 01
Scarce resources, the cost-benefit principle, opportunity cost and sunk cost
- 02
Marginal benefit against marginal cost
- 03
Perfect competition and the supply and demand model
- 04
Shifts of a curve versus movements along it, and comparative statics
- 05
Adding two borrower groups into a kinked total demand for loans
- 06
Willingness to pay, consumer surplus and lenders' surplus
- 07
Rate ceilings, excess demand, rationing and deadweight loss
- 08
The First Welfare Theorem and why the free-market outcome is efficient
- 09
The Australian dollar as a price: demand, supply, appreciation and depreciation
Worked example · free
Deadweight loss from a cap on the loan rate
- 1Equilibrium: 120 − 8i = 4i gives i = 10% and Q = 40. Borrowers' surplus is (15 − 10) × 40 ÷ 2 = 100 and lenders' surplus is 10 × 40 ÷ 2 = 200, a total of 300.
- 1At 7%, lenders supply 4 × 7 = 28 while borrowers want 120 − 56 = 64, an excess demand of 36.
- 2The 28 loans go to borrowers willing to pay from 15% down to 15 − 28 ÷ 8 = 11.5%. Their surplus above 7% is a trapezoid: (8 + 4.5) ÷ 2 × 28 = 175. Lenders now get 7 × 28 ÷ 2 = 98.
- 2Total surplus falls from 300 to 175 + 98 = 273, so the deadweight loss is 27, the triangle (11.5 − 7) × (40 − 28) ÷ 2.
Key terms
- Sunk cost
- A cost already incurred that no present choice can recover. Rational decisions ignore it and compare only the costs and benefits that still depend on the choice.
- Comparative statics
- The comparison of a market's equilibrium before and after one condition changes, read by shifting the affected curve and finding the new price and quantity.
- Excess demand
- The gap between quantity demanded and quantity supplied at a price held below equilibrium, such as a capped interest rate; it forces some form of rationing.
- Lenders' surplus
- The area between the deposit rate received and the supply curve of funds: what savers gain from lending at the market rate over the minimum rate they would accept.
- First Welfare Theorem
- The result that a perfectly competitive equilibrium is Pareto efficient, so no reallocation can make someone better off without making someone else worse off.
Markets, Efficiency and the Home Loan Market FAQ
Why does total demand for home loans have a kink?
Each borrower group stops borrowing at its own choke rate. Above the lower group's choke rate only the higher-income group borrows, so total demand follows that group's line; below it the two demands add, giving a flatter segment.
How do you calculate deadweight loss when loans are rationed?
Add borrowers' and lenders' surplus before and after the intervention and take the difference. If the rationing rule gives loans to people who value them less, the loss includes that misallocation as well as the usual triangle.
Does a rate ceiling help borrowers?
Some of them. Borrowers who still get loans pay less and gain, while those squeezed out lose. In the tutorial version high-income borrowers gain and low-income borrowers, served last, lose surplus.
What makes the Australian dollar appreciate?
Anything that raises demand for Australian dollars or reduces their supply, such as higher Australian interest rates relative to the US, which draws foreign investors in and keeps Australian savings at home.
Exam move
Learn the topic as a sequence of diagrams. Draw supply and demand for loans with the rate on the vertical axis, mark the equilibrium, then add a ceiling and shade every area you are asked for: each group's surplus, lenders' surplus and the deadweight loss. Compute each area as a triangle or a trapezoid from the intercepts, and check that the totals before and after differ by your deadweight loss.
For exchange-rate questions, write one line per event naming the curve, its direction and the result, and state when the answer is ambiguous.
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