Suppose that the interest rate paid to savers increases.As a result,Tom wishes to save more.This suggests that,for Tom,
A) the substitution effect is greater than the income effect.
B) the income effect is greater than the substitution effect.
C) utility maximization is not occurring.
D) future consumption is a luxury.

Question

Quizplus · Accepted Answer

According to the substitution effect, when the interest rate increases, the opportunity cost of current consumption increases, making saving relatively more attractive. Therefore, individuals will substitute current consumption for saving. In this case, Tom's desire to save more indicates that the substitution effect is greater than the income effect, implying that he is prioritizing future consumption over current consumption.

Suppose That the Interest Rate Paid to Savers Increases