An increase in the interest rate can cause an income effect by:
A)making future consumption cheaper.
B)changing real income in year two.
C)making present consumption cheaper.
D)all of the above.

Question

Quizplus · Accepted Answer

An increase in interest rate can result in a decrease in real income in the future, which means that the consumer will have lower purchasing power in year two than in year one. This is the income effect of a change in interest rate. While changes in interest rates can also affect present and future consumption costs (choices A and C), only option B accurately describes the income effect.

An Increase in the Interest Rate Can Cause an Income