If the substitution effect is stronger than the income effect,an increase in real interest rates will lead to ________ in aggregate consumption and will lead to ________ in household saving.
A) an increase; a decrease
B) a decrease; a decrease
C) a decrease; an increase
D) an increase; an unclear change

Question

Quizplus · Accepted Answer

If the substitution effect is stronger than the income effect, an increase in real interest rates will lead to a decrease in aggregate consumption (substitution effect reduces consumption as the cost of borrowing increases) and will lead to a decrease in household saving (income effect reduces saving as the purchasing power of income decreases due to lower consumption). Therefore, the correct answer is B.

If the Substitution Effect Is Stronger Than the Income Effect,an