Suppose an individual has a fixed amount of wealth to allocate between consumption in two periods (c₁ and c₂) .Any funds not spent in period 1 will earn interest (at the rate r) which will increase purchasing power in period 2.Consider four possible reactions to an increase in r:
I.c₁ increases.
II.c₁ decreases.
III.c₂ increases.
IV.c₂ decreases.
Which of these is consistent with the hypothesis that both c₁ and c₂ are normal goods?

Question

Quizplus · Accepted Answer

If both c₁ and c₂ are normal goods, then as interest rates increase, the individual would want or be able to spend more in both periods, so choices I, II, and III are consistent with this. However, if c₂ were an inferior good (meaning demand decreases as income or purchasing power increases), then choice IV would be inconsistent with the hypothesis. Therefore, since all four choices are consistent with the hypothesis that both goods are normal, the answer is D.

Suppose an Individual Has a Fixed Amount of Wealth to Allocate