The income effect of an increase in the interest rate (when "Consumption when young" and "Consumption when old" are both normal goods)will result in
A)an increase in saving when young.
B)an increase in saving when old.
C)a decrease in saving when young.
D)a decrease in saving when old.

Question

Quizplus · Accepted Answer

An increase in the interest rate makes saving more attractive, so the individual will choose to save more when young. This, in turn, will result in a decrease in consumption when young. Since both "Consumption when young" and "Consumption when old" are normal goods, a decrease in consumption when young will lead to a decrease in consumption when old as well. Therefore, the income effect of an increase in the interest rate will result in a decrease in saving when young.

The Income Effect of an Increase in the Interest Rate