The substitution effect that occurs when interest rates change involves a change in consumption that develops from ________.
A)a change in the general level of prices
B)a period of increasing productivity
C)a change in the level of income
D)a change in the relative prices of consumption in the two periods

Question

Quizplus · Accepted Answer

The substitution effect occurs when there is a change in relative prices between two periods. This means that consumers will switch their consumption choices to maximize their utility, given the new prices. In the case of interest rates changing, the relative price of consumption becomes different between the present period and the future period, leading to a substitution effect where consumers may save more in the present or future period depending on the change in interest rates. Changes in the general level of prices (A), periods of productivity (B), and income (C) may all impact a consumer's overall budget constraint and purchasing power, but they do not directly cause the substitution effect that occurs when interest rates change.

The Substitution Effect That Occurs When Interest Rates Change Involves