In a two-period model of choice, an individual initially chooses to consume more than their current income. A subsequent decrease in the interest rate will unambiguously cause this individual to increase their current consumption.
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Savings Decisions and Interest Rate Changes
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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In a two-period model of choice, an individual initially chooses to consume more than their current income. A subsequent decrease in the interest rate will unambiguously cause this individual to increase their current consumption.
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In the model of choice over time, where an individual decides between 'consumption now' and 'consumption in the future', match each graphical component to its correct economic interpretation.
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