Question

    Crusoe begins with an endowment A. Point R is the

    consumption combination he would choose at real interest rate r and point R´ is the consumption combination he would choose at real interest rate r´. Which of the following statements is true?
    A Crusoe is a lender today Correct Answer Incorrect Answer
    B Crusoe’s wealth has decreased because of the change in the real interest rate Correct Answer Incorrect Answer
    C The marginal rate of intertemporal substitution at R is equal to r. Correct Answer Incorrect Answer
    D The change in interest rate does not decrease Crusoe’s utility since he is free to keep his original endowment A if he so chooses Correct Answer Incorrect Answer
    E None of these Correct Answer Incorrect Answer

    Solution

    Crusoe's wealth has decreased because of the change in the real interest rate. Because Crusoe's endowment and preferences are such that he is a borrower, the increase in the interest rate hurts him. Note the MRS = 1+r at point R.

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