If an increase in the interest rate lowers savings, then
A)the substitution effect is greater than the income effect.
B)the income effect is greater than the substitution effect.
C)the income effect and the substitution effect move in the same direction.
D)we are unable to determine the sizes of the income and substitution effects without more information.

Question

Quizplus · Accepted Answer

An increase in interest rate leads to a lower return on savings. This reduces the income people receive from their savings, which lowers their purchasing power, thereby decreasing their willingness to save. It is the income effect that dominates in this situation, leading to a decrease in savings.

If an Increase in the Interest Rate Lowers Savings, Then