Principles of Economics- Mankiw (5th) 470

Principles of Economics- Mankiw (5th) 470 - 484 PA R T S E...

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484 PART SEVEN ADVANCED TOPIC Now consider what happens when the interest rate increases from 10 percent to 20 percent. Figure 21-16 shows two possible outcomes. In both cases, the budget constraint shifts outward and becomes steeper. At the new higher interest rate, Sam gets more consumption when old for every dollar of consumption that he gives up when young. The two panels show different preferences for Sam and the resulting response to the higher interest rate. In both cases, consumption when old rises. Yet the re- sponse of consumption when young to the change in the interest rate is different in the two cases. In panel (a), Sam responds to the higher interest rate by con- suming less when young. In panel (b), Sam responds by consuming more when young. Sam’s saving, of course, is his income when young minus the amount he con- sumes when young. In panel (a), consumption when young falls when the interest rate rises, so saving must rise. In panel (b), Sam consumes more when young, so
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This note was uploaded on 07/30/2010 for the course ECON 120 taught by Professor Abijian during the Spring '10 term at Mesa CC.

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