Consider a consumer who is initially a lender. What are the effects of a decreas

Question

1. Consider a consumer who is initially a lender. What are the effects of a decrease in the real interest rate on this consumer

Consider a consumer who is initially a lender. What are the effects of a decrease in the real interest rate on this consumer's consumption in each period, and on savings? Show how your results depend on income and substitution effects. Using a diagram, explain how it is possible that this consumer's utility does not change and he/she turns into a borrower after the real interest rate decrease. if this consumer's utility does not change and he/ she turns into a borrower after the real interest rate decreases, which effect must dominate, the income or substitution effect, of the decrease in the real interest rate. Explain your answer.

Explanation / Answer

I can help you out with 2 parts of the question.!!

1.If the consumer is a lender then if there is decrease in real interest rates then he will get less money from the borrower due to decrease in interest rate and hence savings of the individual decreases and consumer consumption decreases.

Resluts depend on income and substituon effect as there is change in consumption which is also due to income effect and also there is change in relative price due to change in interest rate so there is also a change in substitution rate.Hence result depend on income and substitution effects.

3.In this case the income effect dominateswith the decrease in real interest rate since decrease in interest rate will increase the consumption level and hence the income effect.

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