In Irving Fisher's two-period model, if the consumer is initially a saver and the interest rate increases, and first-period consumption decreases, 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 decreased consumption.

Question

Quizplus · Accepted Answer

In Irving Fisher's two-period model, when the interest rate increases, the consumer's intertemporal budget constraint shifts leftward. This generates both income and substitution effects on consumption. Since the consumer is initially a saver, his or her first-period consumption decreases in response to the interest rate increase. This indicates that the substitution effect dominates the income effect, leading to a net decrease in consumption. Therefore, Option B is the best choice.

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