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    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 CrusoeтАЩs 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 CrusoeтАЩs utility since he is free to keep his original endowment A if he so chooses 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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