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Consider another consumer that lives for two periods and chooses consumption in period 1 and in...

Consider another consumer that lives for two periods and chooses consumption in period 1 and in period 2. At the current interest rate of 10% the consumer lends $10,000. If the interest rate increases to 30%, what will happen to consumption in period 1 (current consumption)?

(a) Consumption in period 1 increases unambiguously.

(b) Consumption in period 1 decreases unambiguously.

(c) Consumption in period 1 increases only if the substitution effect dominates the income effect.

(d) Consumption in period 1 could either increase or decrease (uncertain).

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Answer #1

Answer is option D)

For a saver, if r rises, then Consumption in period 2 will surely rise.

But C1 can rise or fall

If income effect is stronger, then C1 will rise

If Substitution effect is stronger , then C1 will fall

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