Income and Substitution Effects of a Higher Interest Rate for a Borrower
When the interest rate rises, a borrower faces two effects that both push toward reducing current consumption. The income effect is negative because the borrower becomes poorer, which leads to consuming less now, assuming consumption is a normal good. The substitution effect also leads to less current consumption because it has become relatively more expensive compared to future consumption. Thus, for a borrower, the two effects work in the same direction to decrease present consumption.
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Introduction to Microeconomics Course
The Economy 2.0 Microeconomics @ CORE Econ
Ch.9 Lenders and borrowers and differences in wealth - The Economy 2.0 Microeconomics @ CORE Econ
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