Consider the budget constraint between "spending today" on the horizontal axis and "spending a year from today" on the vertical axis. Suppose that you have $100 today and expect to receive $100 one year from today. Your money market account pays an annual interest rate of 25%, and you may borrow money at that interest rate. Suppose now that the interest rate decreases to 10%. What happens to the slope of your budget constraint relative to when the interest rate was 25%? The slope
A)becomes steeper.
B)becomes flatter.
C)doesn't change because the budget constraint shifts in parallel to the original budget constraint.
D)doesn't change because the budget constraint shifts out parallel to the original budget constraint.

Question

Quizplus · Accepted Answer

When the interest rate decreases, the opportunity cost of spending today increases because the interest earned from saving today is lower. As a result, the slope of the budget constraint becomes flatter. This is because each additional dollar spent today reduces the amount that can be saved for the future by less than it would have at the higher interest rate.

Consider the Budget Constraint Between "Spending Today" on the Horizontal