Question 4 Change in interest rate: Borrower (2.5 points)

a) Depict in a graph the optimal consumption bundle of a consumer who is a borrower in the two-period credit market model

b) Now suppose that the real interest rate falls. Show graphically how this change affects the choice of current and future consumption (you can use the graph from part (a)).

c) Describe the substitution effect and the income effect of the decrease in real interest rate on current and future consumption.

d) Suppose that the substitution effect dominates the income effect. How does a decrease in real interest rate affect savings. Briefly explain.