B6.
528 B • Indifference Curves

FIGURE B6 Indifference Curve and an Intertemporal Budget Constraint The original choice is A, at the tangency

between the original budget constraint and the original indifference curve Uh. The dashed line is drawn parallel to

the new budget set, so that its slope reflects the lower rate of return, but is tangent to the original indifference

curve. The movement from A to C is the substitution effect: in this case, future consumption has become relatively

more expensive, and present consumption has become relatively cheaper. The income effect is the shift from C to B;

that is, the reduction in utility or “buying power” that causes a move to a lower indifference curve Ul, but with the

relative price the same. It means less present and less future consumption. In the move from A to B, the

substitution effect on present consumption is greater than the income effect, so the overall result is more present
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