In Irving Fisher's two-period model, if the consumer is initially a saver and the interest rate and first-period consumption increase, then we can conclude that the income effect:
A) was greater than the substitution effect.
B) was less than the substitution effect.
C) exactly offset the substitution effect.
D) and the substitution both increased consumption.

Question

Quizplus · Accepted Answer

When the interest rate increases, the substitution effect typically encourages saving by making future consumption more attractive relative to current consumption. However, if the consumer increases first-period consumption despite the higher interest rate, it indicates that the income effect (which makes the consumer feel wealthier and thus encourages more consumption in both periods) dominated the substitution effect.

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