Assume that Brenda has positive wealth. As the interest rate decreased, Brenda reduced her current consumption. For Brenda,

Question

Quizplus · Accepted Answer

The income effect of an interest rate decrease means that Brenda's purchasing power has increased, which should lead her to increase consumption. However, the substitution effect of an interest rate decrease means that the opportunity cost of current consumption has decreased (i.e. the benefit of saving has decreased), which should lead her to decrease consumption. If Brenda has reduced her current consumption, it means that the substitution effect is larger than the income effect, so B is the correct answer. C and D are incorrect because they make assumptions that are not necessarily true, and A is incorrect because it implies that Brenda would increase her current consumption in response to an interest rate decrease, which goes against the assumption in the question.

Assume That Brenda Has Positive Wealth