Suppose the interest rate grows from 6 percent to 8 percent and the volume of current saving advances at the same time from $125 billion to $130 billion. This simultaneous movement in interest and savings volume describes the:
A) Income Effect
B) Substitution Effect
C) Wealth Effect
D) Inflation Effect
E) None of the above

Question

Quizplus · Accepted Answer

The increase in interest rates from 6 percent to 8 percent makes saving more attractive relative to spending, which is a classic example of the substitution effect. The substitution effect occurs when consumers change their consumption of goods or services in response to changes in relative prices or in this case, the relative return on savings versus spending.

Suppose the Interest Rate Grows from 6 Percent to 8