In the two-period model, a lower real interest rate
A)reduces the present value of income.
B)causes the budget constraint to rotate in a clockwise direction.
C)makes households that had initially planned to save better off.
D)makes households that had initially planned to borrow better off.

Question

Quizplus · Accepted Answer

A lower real interest rate reduces the cost of borrowing, making households that had initially planned to borrow better off. This is because they can now obtain the same amount of funds for a lower cost, which increases their purchasing power. In contrast, households that had planned to save may be worse off since their expected returns on savings will be lower with a lower real interest rate.

In the Two-Period Model, a Lower Real Interest Rate