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  • Interest Rate as the Opportunity Cost of Present Consumption

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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References

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Social Science

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CORE Econ

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Economy

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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