A central bank raises its policy interest rate from 4% to 6%. Commercial banks respond by increasing the interest rate charged on loans to households and fi...
Question 1 Report
A central bank raises its policy interest rate from 4% to 6%. Commercial banks respond by increasing the interest rate charged on loans to households and firms. A car dealer is concerned that demand for its cars will fall.
(a) Explain how the higher policy rate can reduce demand for cars bought on credit. [3]
(b) Analyse one possible effect of lower car sales on the dealer's workers and profit. [3]
Answer Details
(a) A higher central-bank policy rate makes it more expensive for commercial banks to obtain or provide funds, so commercial banks raise the interest rates charged on loans. [1] Monthly repayments on car loans become more expensive. [1] Some consumers can no longer afford a credit-financed car, or choose to delay buying one, so demand for cars falls. [1]
(b) Lower demand means fewer cars are sold, reducing the dealer's sales revenue. [1] The dealer may respond by cutting workers' hours, wages or employment because fewer staff are needed to sell and prepare cars. [1] Since revenue falls while costs such as rent may continue, the dealer's profit is likely to fall. [1]
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