substitution and income effects provides a framework for thinking about the motivations behind various

choices. The dashed line, which is a graphical tool to separate the substitution and income effect, is carefully

inserted with the same slope as the new opportunity set, so that it reflects the changed rate of return, but it is

tangent to the original indifference curve, so that it shows no change in utility or “buying power.”

The substitution effect tells how Quentin would have altered his consumption because the lower rate of return

makes future consumption relatively more expensive and present consumption relatively cheaper. The

movement from the original choice A to point C shows how Quentin substitutes toward more present

consumption and less future consumption in response to the lower interest rate, with no change in utility. The
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