Asked by Jesse Gonzalez on Jun 01, 2024
Verified
Joseph is planning ahead for retirement and must decide how much to spend and how much to save while he's working in order to have money to spend when he retires. When the substitution effect dominates the income effect, an increase in the interest rate on savings will cause him to
A) increase his savings rate.
B) decrease his savings rate.
C) continue saving at the current rate.
D) change his savings rate but in an unknown way.
Interest Rate
The cost of borrowing money or the return on investment, expressed as a percentage, charged by lenders to borrowers for the use of their money.
Substitution Effect
The change in demand for a good or service caused by a change in its price, making consumers replace it with a cheaper alternative.
Income Effect
A change in consumption patterns resulting from a change in real income due to variations in prices, other factors remaining constant.
- Understand the implications of changes in interest rates on savings and consumption over different periods.
Verified Answer
MB
Myranda BurtonJun 06, 2024
Final Answer :
A
Explanation :
When the substitution effect dominates the income effect, an increase in the interest rate on savings makes saving more attractive compared to spending because the opportunity cost of spending (foregone interest earnings) is higher. Therefore, Joseph is likely to increase his savings rate to take advantage of the higher returns on savings.
Learning Objectives
- Understand the implications of changes in interest rates on savings and consumption over different periods.