In practice,it is usual to assume that,in explaining the impact of a change in interest rates ________.
A)the substitution effects outweigh the income effects
B)the income effect outweighs the substitution effect
C)the income and substitution effects cancel out with one another
D)the income effect increases the severity of the substitution effect

Question

Quizplus · Accepted Answer

In explaining the impact of a change in interest rates, it is usual to assume that the substitution effects outweigh the income effects. This is because when interest rates rise, the cost of borrowing increases, leading to a decrease in borrowing and an increase in saving. This decrease in borrowing results in a decrease in the quantity demanded of goods and services, and an increase in the quantity supplied. Substitution effects are the changes in the quantity demanded and supplied due to changes in the relative prices of goods and services. On the other hand, the income effect is the change in the quantity demanded of goods and services due to changes in the consumer's income. While the income effect may also impact the quantity demanded of goods and services, the substitution effect is typically stronger. Therefore, in this context, the substitution effect outweighs the income effect.

In Practice,it Is Usual to Assume That,in Explaining the Impact