If consumption when young and when old are both normal goods, an increase in the interest rate ?
Correct answer: C. will increase the quantity of saving if the substitution effect outweighs the income effect
- A. will always increase the quantity of saving
- B. will always decrease the quantity of saving
- C. will increase the quantity of saving if the substitution effect outweighs the income effect
- D. will increase the quantity of saving if the income effect outweighs the substitution effect
Explanation
A higher interest rate makes future consumption relatively cheaper than current consumption, encouraging saving through the substitution effect. Saving rises when this effect is stronger than the income effect, which may work in the opposite direction.
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