How does interest change the price of present relative to future consumption?
The intertemporal budget combines income in present value, and interest sets the c1–c2 slope.
Follow the cause and effect
Write c1+c2/(1+r)=y1+y2/(1+r).
Solve the choice and compare c1 with y1 to classify borrowing or saving.
When r changes, account for the endowment income effect, which differs by position.
The model you are using
Conditions for this model
Certainty, unit real consumption prices, equal borrowing and lending rates, and no terminal debt.
The exam trap
A higher interest rate does not guarantee more saving because a saver’s income effect may oppose substitution.
Connect the reasoning to the graph
What changes
- The budget pivots through the endowment (y1,y2) when interest changes because autarky remains feasible.
What stays fixed
Certainty, unit real consumption prices, equal borrowing and lending rates, and no terminal debt.
Keep these conditions throughout the comparison; change only what the case above specifies.
What to inspect
When r changes, account for the endowment income effect, which differs by position.
Compare before and after, and locate the conclusion on the graph.
5 MINUTES · TRANSFER THE IDEA
Can you explain it without the lesson?
Draw a borrower and saver when r rises and separate definite from ambiguous effects.