Michael faces tradeoffs between consuming in the current period when he is young and consuming in a future period when he is old. Michael experiences a decrease in the current interest rate he earns on his savings. Michael will save
A)less in the current period if the substitution effect is greater than the income effect.
B)less in the current period if the income effect is greater than the substitution effect.
C)more in the current period if the substitution effect is greater than the income effect.
D)more in the current period, regardless of the sizes of the income and substitution effects.

Question

Quizplus · Accepted Answer

A decrease in the interest rate makes saving less attractive, so if the substitution effect (preference for current consumption over future consumption due to lower returns) is greater than the income effect (need to save more to achieve the same future consumption), Michael will save less.

Michael Faces Tradeoffs Between Consuming in the Current Period When