cheaper to earn future consumption and less present consumption (more savings), since the opportunity cost

of present consumption in terms of what is being given up in the future has increased. The income effect of an

interest rate increase is to choose more of both present and future consumption, since they are both normal

goods. The substitution and income effects of an interest rate decrease would reverse these directions.

Review Questions

Exercise B1

What point is preferred along an indifference curve?

Exercise B2

Why do indifference curves slope down?

Exercise B3

Why are indifference curves steep on the left and flatter on the right?

Exercise B4

How many indifference curves does a person have?

Exercise B5

How can you tell which indifference curves represent higher or lower levels of utility?

Exercise B6

What is a substitution effect?

Exercise B7

What is an income effect?

Exercise B8

Does the “income effect” involve a change in income? Explain.

Exercise B9
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