Fred is considering consumption between two periods and is earning an income of $1,000 in both periods.If the interest rate is 8 percent,Fred borrows $500,but if the interest rate rises to 18 percent,Fred saves $500.Is this behavior economically reasonable?
A)No,Fred would borrow less because of the higher interest rate but would still borrow a positive amount.
B)No,Fred might not borrow at all,but would not start saving.If Fred wanted to save he would have saved at the lower interest rate too.
C)Yes,the change in interest rates will cause his endowment point to shift,allowing him to become a saver.
D)Yes,the higher interest rate will raise the cost of current consumption,inducing him to cut back current consumption.He could cut back so much that he becomes a saver.

Question

Quizplus · Accepted Answer

The higher interest rate will raise the cost of current consumption, inducing Fred to cut back on current consumption. If he cuts back enough, he could become a saver. This behavior is economically reasonable as it follows the basic principles of intertemporal choice and rational decision-making. Option A is incorrect as Fred can still borrow but at a lower amount. Option B is incorrect as Fred can save at a higher interest rate as it would yield higher returns. Option C is incorrect as the change in interest rates does not necessarily mean that Fred will become a saver.

Fred Is Considering Consumption Between Two Periods and Is Earning