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Think of this question in the context of a two-period model. Suppose the consumer is initially...

Think of this question in the context of a two-period model.

Suppose the consumer is initially a borrower. If the real interest rate falls, how does she respond? Briefly explain.

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Answer #1

Answer) The answer to this question is related to two period intertemporal choice model. If the consumer is initially borrower then if the rate of interest falls then the consumer will be worse off because then she might have borrowed the money at lower rate of interest but she has to pay high rate of interest in camparison to second period. The consumer spending of present period will be low and future consumption wil rise. In this situation, lender is better off as now he/she will be getting high rate of interest in camparison to second period rate of interest.

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