Consider the following diagram r 2 must be (none/smaller than/greater than/incom
ID: 1150945 • Letter: C
Question
Consider the following diagram
r2 must be (none/smaller than/greater than/income/substitution/lender/borrower/equal to) r1.
At r1, the consumer is a (none/smaller than/greater than/income/substitution/lender/borrower/equal to).
Going from A to D is the (none/smaller than/greater than/income/substitution/lender/borrower/equal to) effect, while going from D to B is the (none/smaller than/greater than/income/substitution/lender/borrower/equal to) effect.
In this example, the income effect on c is (none/smaller than/greater than/income/substitution/lender/borrower/equal to) the substitution effect.
Explanation / Answer
As the slope of the budget line is increased so r2 must be greater than r1.
Because of increasing interest rate consumers want to consume less in current and wants to consume more in future so at r1 consumers is a lender
Going from A to D is the substitution effect.
While going from D to B is the income effect.
Substitution effect decreases the current consumption from A to D. But income effect increase the current consumption from D to B. At point A and B current consumption is same so the income effect on c is equal to the substitution effect.