In Irving Fisher's two-period model, if the consumer is initially saving in period one and the real interest rate rises, then:
A) both the income and substitution effects will make the consumer want to consume less in period one.
B) both the income and substitution effects will make the consumer want to consume more in period one.
C) the substitution effect will make the consumer want to consume less in period one but the income effect will make him or her want to consume more.
D) the income effect will make the consumer want to consume less in period one, but the substitution effect will make him or her want to consume more.

Question

Quizplus · Accepted Answer

In Irving Fisher's two-period model, when the real interest rate rises, the substitution effect will make the consumer want to save more in period one and consume less, while the income effect will make the consumer want to consume more in period one due to the increase in purchasing power resulting from the increased interest income earned on savings. Therefore, the substitution effect outweighs the income effect, making the consumer want to consume less in period one. Hence, the correct choice is C, where the substitution effect will make the consumer want to consume less in period one, but the income effect will make him or her want to consume more.

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