4)

1.

Consider a consumer who is initially a

lender

. What are the effects of a decrease in the

real interest rate on this consumer's consumption in each period, and on savings? Show

how your results depend on income and substitution effects.

2.

Using a diagram, explain how it is possible that this consumer's utility does not change

and he/she turns into a borrower after the real interest rate decreases.

3.

If this consumer's utility does not change and he/she turns into a borrower after the real

interest rate decreases, which effect must dominate, the income or substitution effect, of

the decrease in the real interest rate? Explain your answer.