Suppose you know I are only about consumption this year and consumption next year.Suppose also that I have an income this year but do not expect to have an income next year.Explain your answers.
a.You notice that I save more after the interest rate falls.Can you tell whether "consumption now" is a normal,inferior or Giffen good?
b.Suppose I also received an unexpected raise at work and you overhear me say: "Cool,I am even Steven.Now that I have my raise,I am just as happy as I was before the interest rate fell and I did not yet have a raise." Without knowing anything more,can you tell whether I consume more or less next year than I would have consumed had neither of the two changes happened?

Question

Quizplus · Accepted Answer

The Answer is a.Yes,you can tell.A drop in the interest rate gives rise to a substitution effect that says consume more now.If consumption now actually falls,it means that the wealth effect pushed in the opposite direction (for a decrease in wealth from the compensated to the final budget)-- so consumption now is a normal good.
b.Here,we are staying on the same indifference curve -- but the slope of the budget has become shallower.This implies a move to the right along the indifference curve -- a move to more consumption now and less consumption next year.(This is,of course,just a pure substitution effect.)

Suppose You Know I Are Only About Consumption This Year