In Irving Fisher's two-period model, if the consumer is initially saving in period one and the real interest rate rises, then first-period consumption will:
A) certainly fall.
B) certainly rise.
C) remain constant.
D) either rise or fall.

Question

Quizplus · Accepted Answer

In Irving Fisher's two-period model, if the real interest rate rises, the substitution effect encourages more saving (less consumption) in the first period because future consumption becomes relatively cheaper. However, the income effect, due to increased return on savings, might encourage more immediate consumption if the consumer feels wealthier. The net effect on first-period consumption depends on the relative strengths of these two effects, so it could either rise or fall.

In Irving Fisher's Two-Period Model, If the Consumer Is Initially