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

consumption. Notice that the lower indifference curve could have been drawn tangent to the lower budget

constraint point D or point F, depending on personal preferences.

Taking both effects together, the substitution effect is encouraging Quentin toward more present and less

future consumption, because present consumption is relatively cheaper, while the income effect is

encouraging him to less present and less future consumption, because the lower interest rate is pushing him

to a lower level of utility. For Quentin’s personal preferences, the substitution effect is stronger so that, overall,

he reacts to the lower rate of return with more present consumption and less savings at choice B. However,

other people might have different preferences. They might react to a lower rate of return by choosing the same
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