A consumption-based theory of the determination of the real interest rate is based on the assumption that:

Question

A consumption-based theory of the determination of the real interest rate is based on the assumption that:​

Quizplus · Accepted Answer

A consumption-based theory of the determination of the real interest rate posits that the real interest rate has to adjust so as to make individuals willing to experience changes in their consumption levels over time. In other words, this theory suggests that people determine how much they consume and save, based on expected future income and current interest rate. Thus, the theory suggests an intertemporal tradeoff between consumption and investment that is determined by the real interest rate. Therefore, choice B is the correct answer. Choice A is incorrect because an increase in the real interest rate is likely to reduce current consumption rather than increase it. Choice C is incorrect because a consumption-based theory suggests that the real interest rate is not determined by the supply and demand for investment alone. Finally, choice D is incorrect because the statement is a tautology that does not add any meaningful insight into the consumption-based theory of interest rate determination.

A Consumption-Based Theory of the Determination of the Real Interest