If Gold Prices Are The Same Everywhere, Then Why Aren't House Prices - Research Proposal Example

If Gold Prices Remain the Same, Why arent the House Prices? Gold and housing are products that people normally trade in exchange of money. Despite being considered as a commodity, gold has a special purpose considering that these are used to enable people to purchase new products and services. Considering the history of global trading system, economic reasons that will provide the readers a good explanation why the market value of gold remains the same but not the market price of houses will be highlighted in the study. Table of Contents I. Abstract …………………………………………………………………… 2 II. Table of Contents ……………………………………………………….. 3 III. Introduction ……………………………………………………………….. 4 IV. History of the Global Trading System ………………………………….. 4 V. Significant Changes within the domestic markets that Affects the Market Value of Houses …………………………………….. 6 V. Conclusion …………………………………………………………………. 9 References ……………………………………………………………………… 10 - 11 Introduction The study of microeconomics enables us to understand the basic interaction between each individual, the household, and firms in terms of making decisions in allocating the available resources. Using the basic economic supply and demand curve, it is easier for us to examine how prices and available supply affects the existing market behavior. To enable us to understand the major factor that make the prices of gold remains the same over time but not the housing prices, the history of the global trading system will first be tackled. Using the theories of microeconomics, significant changes within the domestic markets that contributes to the changes in the market value of houses will be thoroughly discussed. History of the Global Trading System Between the years 1879 to 1934, trading of goods between two countries occurred using of the gold standard which enabled traders to pay goods and services in exchange with the quantity of gold (McConnell & Brue, 2004: p. 478). Since the value of gold remains the same in each country, there was officially a fixed exchange rate all over the world. Eventually, the use of fixed exchange rate resulted to a negative international demand shock since the prices goods from one country to another remains the same (Eichengreen, 1996). The global economic depression that happened back in 1930s changes the concept of having fixed exchange rate. (McConnell & Brue, 2004: p. 479) In order to promote free competition within the domestic and global trading markets, some nations have considered making the cost of exportation cheaper by devaluating their currency against the real value of gold. As part of strengthening the adjustable-peg system which was introduced under the Bretton Woods System1, each country agreed to accept gold and the US dollar as the benchmark for international reserves since the US was able to accumulate the biggest supply of gold as compared with other countries (McConnell & Brue, 2004: p. 480). As a result, the agreed equivalent of gold in terms of the US dollar is US$35 per ounce (Bougrine & Seccareccia, 2004). Aiming to avoid economic bias between the Americans and people across the world, the central bank strictly prohibits any Americans to purchase gold using the agreed conversion rate which is US$35 per ounce of gold. Instead, the Americans were allowed to purchase gold based on the prevailing market price (de Grauwe, 1996: p. 17). Over the years, a lot of economists have argued whether or not it was a right choice to fix the value of US dollar and gold as a reserve medium at US$35 per ounce since the U.S. has accumulated as much as $70 billion worth of payment deficits with only $12 billion worth of gold (Yarbrough & Yarbrough, 1994: p. 641). It was only in August 1971 when the United States decided to solve the problem by allowing the value of US dollar and gold to ‘float’ in the world market depending on its own economic performance. (Hammes & Wills, 2005; James, 1996: pp. 215 – 220) Since then, the real value of gold increases over time. It even reached as much as 1,200 percent increase within a short span of 5 years (Hammes & Wills, 2005). In other words, even though that the value of US dollar was allowed to free float with the international market, the fact that the prices of gold is still pegged with the US dollar makes the real prices of gold remain same. Significant Changes within the domestic markets that Affects the Market Value of Houses Changes in the prevailing market price of houses can be explained with the significant shift in the demand and supply curve. Based on the microeconomic theory, there is a cycle that goes around the household, market, and firms in the sense that members of the household finds employment from the firm in order to earn salary and wages to support their financial needs. On the other hand, the money that each household receive will be used in purchasing products and services they need in order to survive. Consumers’ inability to purchase a new house is an after effect of globalization, the weakening US economy, and the high unemployment rate. Over the past decade, globalization has inspired a lot of US-based companies to transfer a portion of their business operations in other developing countries. Aside from shifting some available jobs to developing countries, local businesses in the Unites States need to make the company more efficient by maximizing the use of its existing human resources which is necessary in order to keep their business competitive in the world market. As a result, the US national unemployment rate increased from 4.5 in July 2007 to 5.7% in July 2008 (U.S. Department of Labor, 2007 & 2008). Since a large number of people in the United States are either totally unemployed or is just working on a part-time job, most individuals with just enough income would choose to hold on to their dollar instead of investing on new properties. Even though the demand for houses is remains high, the lack of financial resources caused by high unemployment rate can cause the demand curve to shift to the left which causes the market price of houses to go down. Aiming to reduce the market prices of these houses, homebuilders will be forced to downgrade some of the materials they use in building the houses (Business Wire 2006). (See Graph I – Housing Demand Declines below) Graph I – Housing Demand Declines On the contrary, when the US economy was good, there is a tendency for the national unemployment rate to go down since US-based companies will need more human resources to meet the work demand. Since more employees will be employed, more people will be able to afford to invest on new houses. When the demand for housing goes up, there is a tendency for its prevailing market price to go up given that the demand curve will shift to the right. (See Graph II – Housing Demand Increases below) Graph II – Housing Demand Increases Aside from the ability of the people to purchase new houses, the fact that there is a perfect competition within the US housing industry could also affect the prevailing market price of houses. Since there are many small- and large-scale housing firms that serve the housing needs of the Americans, the market price of houses is a major factor that encourages the target buyers to purchase a house. Therefore, homebuilders normally consider the market price its target buyers can afford to purchase. Conclusion Even though both gold and houses can be considered as a commodity, the fact that gold was used in paying other products and services during the gold standard and the Bretton Woods System made the people behind the central bank and international monetary fund (IMF) peg the value of gold with the value of the US dollar. This makes the market value of gold the same at all times despite the fact that the US dollar has been allowed to float in the market. On the other hand, prevailing market price of houses varies from time to time depending on the capacity of the people to purchase new houses. *** End *** References: Bougrine, H., & Seccareccia, M. (2004). Alternative exchange rate arrangements and effective demand: an important missing analysis in the debate over greater North American monetary integration. Journal of Post Keynesian Economics , 26(4):655 - 677. Business Wire. (2006, December 7). Retrieved September 14, 2008, from Fitch: Will Soft Landing Become Hard Thud For U.S. Homebuilding In 2007?: http://findarticles.com/p/articles/mi_m0EIN/is_2006_Dec_7/ai_n27078816 DeGrauwe, P. (1996). International Money: Postwar Trends and Theories, 2d ed. Oxford: Oxford University Press. Eichengreen, B. (1996). Globalizing Capital: A History of the International Monetary System. Princeton: Princeton University Press. Hammes, D., & Wills, D. (2005). Black Gold: The End of Bretton Woods and the Oil-Price Shocks of the 1970s. The Independent Review , 9(4):501 - 511. James, H. (1996). International Monetary Co-operation Since Bretton Woods. Washington, DC and NY: IMF and Oxford University Press. McConnell, C. R., & Brue, S. L. (2004). Microeconomics. 16th Edition. McGraw-Hill Higher Education. U.S. Department of Labor. (2007). Retrieved September 14, 2008, from REGIONAL AND STATE EMPLOYMENT AND UNEMPLOYMENT: APRIL 2007: http://www.bls.gov/news.release/History/laus_05182007.txt U.S. Department of Labor. (2008). Retrieved September 14, 2008, from Bureau of Labor Statistics: Regional and State Employment and Unemployment Summary: http://www.bls.gov/news.release/laus.nr0.htm Yarbrough, B., & Yarbrough, R. (1994). The World Economy. 3rd ed. Orlando, Fla.: Dryden Press. Read More