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a) What are the two channels through which an increase in the real interest rate affects...

a) What are the two channels through which an increase in the real interest rate affects consumption decisions?

(b) Suppose your income in year 1 is $1,000 and in year 2 it increases to $1,100. If you choose your income following the PIH how much should you consume in each year?

(c) Show graphically what happens to consumption after a fall in permanent income using the indifference curve/budget constraint graph.

(d) Show what happens to the consumption demand curve after a fall in permanent income. You should use your answer to questions 4 in answering this question.

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