Answer to Question #66927 in Microeconomics for Dibya Nag

Question

Consider the overlapping generation model where each member lives for two time period 't' and 't+1'. Assume that individual work in time period 't' and earn wage, while they do not work in time period 't'+1' and survive on interest income. Explain the impact of an increase in interest rate on consumption for time period 't'.

Answer 1

If individuals work in time period ‘t’ and earn wage income, while they do not work in time period (t+1) and survive on interest income, then the impact of an increase in interest rate will decrease consumption during time period ‘t’, because it will be better for them to save more than to spend.