Impact of Future Income Expectations on Current Consumption
Analyze how the change in expected future income described in the case study below is likely to affect the individual's current borrowing and consumption decisions. Explain your reasoning by describing the changes to their budget constraint and the economic effects at play.
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An individual has an income stream that allows them to choose a combination of consumption today and consumption in the future. Initially, they choose to consume less than their current income, saving the remainder. If the interest rate on savings increases, which of the following statements most accurately describes the outcome?
An individual makes a choice between 'consumption today' (horizontal axis) and 'consumption in the future' (vertical axis). Their initial budget constraint is represented by line BL1, and they choose point A on indifference curve I1. At point A, their consumption today is less than their income today. The interest rate then changes, causing the budget constraint to pivot to a new, steeper line, BL2. The individual's new optimal choice is point B, which lies on a higher indifference curve, I2. Based on this information, which of the following conclusions is correct?
An individual makes a choice between 'consumption today' (horizontal axis) and 'consumption in the future' (vertical axis). Their initial budget constraint is represented by line BL1, and they choose point A on indifference curve I1. At point A, their consumption today is less than their income today. The interest rate then changes, causing the budget constraint to pivot to a new, steeper line, BL2. The individual's new optimal choice is point B, which lies on a higher indifference curve, I2. Based on this information, which of the following conclusions is correct?
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