The substitution effect of a decrease in real interest rates is to cause a consumer to
A)increase future consumption and decrease current consumption.
B)decrease future consumption and increase current consumption.
C)increase current consumption and increase saving.
D)decrease current consumption and increase saving.

Question

Quizplus · Accepted Answer

A decrease in real interest rates reduces the return on saving, making current consumption relatively more attractive than future consumption. As a result, consumers are likely to increase current consumption and decrease future consumption, leading to the substitution effect. Choice B correctly reflects this substitution effect. Choice A represents the income effect, while choices C and D do not accurately capture the impact of real interest rate changes on consumer behavior.

The Substitution Effect of a Decrease in Real Interest Rates