Question

At interest rate r0 an individual with strictly convex preferences is neither a borrower nor a saver.

At interest rate r1 > r0 which of the following statements is true?

a. The individual is a borrower and is worse off than with r0.

b. The individual is a saver and is worse off than with r0.

c. The individual is a saver and is better off than with r0.

d. The individual is a borrower and is better off than with r0.

e. None of the above.

Answer 1

It is given that at interest rate r0, the individual is neither a borrower nor a lender. This means that his income is same as the consumption.

Now if the interest rate is r1>r0, this implies that interest rate has risen. Since the interest rate has risen , the individual has an incentive to consume less and save , so that he can earn interest . Here being a borrower would be a disadvantage to him because then a higher interest rate needs to be paid.

So the individual would be a saver and would be better off than with r0 since now he is saving and getting a higher interest rate as additional income. So answer is option C) the individual is a saver and is better off than with r0.

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