If the ________ effect is greater than the ________ effect, a decrease in interest rates will decrease saving and increase consumption spending by households.

Question

Quizplus · Accepted Answer

The income effect refers to the change in consumption that results from a change in real income. The substitution effect refers to the change in the relative price of consuming goods (in this case, present and future consumption) due to a change in interest rates. When interest rates decrease, the price of present consumption decreases relative to future consumption, leading to a substitution effect that encourages households to consume more in the present. However, the income effect may be greater or less than the substitution effect, depending on how much the decrease in interest rates affects households' real incomes. If the income effect is greater than the substitution effect, households will decrease saving and increase consumption spending in response to the decrease in interest rates. Therefore, the correct answer is B, as it specifies that the substitution effect is greater than the income effect.

If the ________ Effect Is Greater Than the ________ Effect

If the Effect Is Greater Than the Effect