5. In Figure 2 a. A lender is initially choosing point A. Then the interest rate

Question

5. In Figure 2 a. A lender is initially choosing point A. Then the interest rate decreases. The substitu- tion efect is from point A to point D and the income effect is from point D to point B. Figure 2: Decrease in real interest rate for lender (the opposite of graph in page 284) e current consumption b. A lender is initially choosing point D·Then the interest rate decreases. The substitu- tion effect is from point D to point A and the income effect is from point A to point B. e.A lender is initially choosing point A. Then the interest rate decreases. The subetitu- tion effect is from point A to point D and the income effect is from point A to point B. d. A lender is initially choosing point D. Then the interest rate decreases. The substi- tution effect is from point D to point A and the income effect is from point D to point B. 6. In Figure 2, after the decrease in the interest rate a. the substitution effect dominates b. the substitution effect suggests that current consumption increases c the substitution effect suggests that current consumption decreases d. the substitution effect suggests that current consumption might increase or decrease 7. In Figure 2, after the decrease in the interest rate a. the income effect dominates. b. the income effect suggests that current consumption increases. c, the income effect suggests that current consumption decreases. d. the income effect suggests that current consumption might increase or decrease

Explanation / Answer

Answer

5)

The correct answer is (a)The lender is currently choosing Point A. Then the interest rate decreases, the suvbstitution effect is from A to point D and income effect is from Point D to Point B.

Initial budget constaint is the line passing through point A and E. At that budget line he is choose Bundle at which budget line is tangent to I hence optimal Point is A. Now if interest rate decreases then this will result in change in budget line but this budget line must be flatter than initial budgel line and must Pass through Endowment(E) Hence, new budget line is Line Passing through Point B and E. Substitution effect is the change in Point that occurs due to change in interest and we have to find that new point whose slope is same as old budget line and gives same utility as Bundle A and that bundle is D. Hence substitution effect is from A to D. and Income effect is the change in point between Price effect and substitution effect and hence Income effect is from D to B

Hence the correct answer is (a)The lender is currently choosing Point A. Then the interest rate decreases, the suvbstitution effect is from A to point D and income effect is from Point D to Point B.

6)

The correct answer is (b) The substitution effect suggest that current consumption increases

As discussed above, substitution effect is from Point A to point D, Hence we we can see from above graph that current consumption at point D is greater than current consumption at point A. Hence substitution effect suggest that current consumption increases.

Hence The correct answer is (b) The substitution effect suggest that current consumption increases

7)

The correct answer is (c) The Income effect suggest that current consumption decreases

As discussed above, income effect is from Point D to point B, Hence we we can see from above graph that current consumption at point D is greater than current consumption at point B. Hence Income effect suggest that current consumption decreases.

Hence The correct answer is (c) The Income effect suggest that current consumption decreases

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