An increase in the real interest rate is an example of a
A) pure substitution effect.
B) substitution effect and a positive income effect.
C) substitution effect and a negative income effect.
D) substitution effect and an income effect whose sign depends on whether the consumer is initially a borrower or a lender.
E) positive substitution effect and a negative income effect.

Question

Quizplus · Accepted Answer

An increase in the real interest rate affects consumers differently depending on whether they are borrowers or lenders. For borrowers, the income effect is negative because they have to pay more interest, reducing their disposable income. For lenders, the income effect is positive because they earn more interest income. The substitution effect encourages saving over spending for both groups.

An Increase in the Real Interest Rate Is an Example