Assuming that consumption during youth and old age are both normal goods, how does a rise in the interest rate affect the amount saved?

Show Answers

It will invariably lead to a higher saving amount.It will invariably cause a reduction in the saving amount.It will raise the saving amount if the substitution effect is stronger than the income effect.It will raise the saving amount if the income effect is stronger than the substitution effect.It will have no impact on the saving amount.

Explanation

When both young and old consumption are normal goods, an increase in the interest rate influences saving depending on the relative strength of two effects. The substitution effect encourages more saving by making future consumption relatively cheaper, while the income effect can reduce saving by increasing overall wealth. Therefore, saving will increase only if the substitution effect dominates the income effect.