The private supply of credit is an increasing function of the real interest rate if
A) the substitution effects outweighs the income effects when added across all consumers.
B) the income effects outweighs the substitution effects when added across all consumers.
C) the income effect outweighs the substitution effects for borrowers.
D) the substitution and income effects cancel each other.
E) consumers are rational.

Question

Quizplus · Accepted Answer

The real interest rate is the opportunity cost of borrowing money, and when it is higher, consumers tend to reduce their borrowing and increase their saving, as the substitution effect outweighs the income effect. As a result, the private supply of credit increases because lenders have more funds available to lend. This is why A is the best choice. B is incorrect because it implies that higher interest rates reduce the private supply of credit, which is not the case. C is partially correct, as the income effect may reduce borrowing for some borrowers, but it does not apply to all consumers, and it does not necessarily outweigh the substitution effect. D is incorrect because the substitution and income effects do not cancel each other, and the real interest rate affects borrowing. E is not directly related to the question and does not provide a relevant explanation.

The Private Supply of Credit Is an Increasing Function of the Real