Joseph is planning ahead for retirement and must decide how much to spend and how much to save while he's working in order to have money to spend when he retires. When the substitution effect dominates the income effect, an increase in the interest rate on savings will cause him to
A)increase his savings rate.
B)decrease his savings rate.
C)continue saving at the current rate.
D)change his savings rate but in an unknown way.

Question

Quizplus · Accepted Answer

When the substitution effect dominates the income effect, an increase in the interest rate on savings makes saving more attractive compared to spending because the opportunity cost of spending (foregone interest earnings) is higher. Therefore, Joseph is likely to increase his savings rate to take advantage of the higher returns on savings.

Joseph Is Planning Ahead for Retirement and Must Decide How