Consider the budget constraint between "spending today" on the horizontal axis and "spending a year from today" on the vertical axis.Suppose that you have $100 today and expect to receive $100 one year from today.Your money market account pays an annual interest rate of 25%,and you may borrow money at that interest rate.Suppose now that the interest rate decreases to 10%.What happens to the slope of your budget constraint relative to when the interest rate was $25%?
A)it becomes steeper
B)it becomes flatter
C)it doesn't change because the budget constraint shifts in parallel to the original budget constraint
D)it doesn't change because the budget constraint shifts out parallel to the original budget constraint

Question

Quizplus · Accepted Answer

The slope of the budget constraint is - (1 + interest rate on borrowing) / (1 + interest rate on saving). 
When the interest rate decreases from 25% to 10%, the slope of the budget constraint becomes less steep (flatter), as the interest rate on borrowing also decreases. This means that the opportunity cost of spending today (in terms of future consumption foregone) has decreased, allowing for more spending today and less saving. Therefore, the budget constraint rotates outward from the origin.

Consider the Budget Constraint Between "Spending Today" on the Horizontal