a. The existing reserves of a relatively small oil company.
b. The total world reserves of an exhaustible natural
resource with a known, completely fixed supply.
c. A long-term bond, issued by a very unstable third-world
government, that promises to pay the bearer $1000 per
year forever.
d. A lottery ticket that your neighbour bought for $10, which
was one of 1 million tickets sold for a drawing that will be
held in one year’s time paying $2 million to the single
winner.
8. Since the interest rate is the price of financial capital, a change in
the interest rate generates both an income effect and a
substitution effect.
a. Explain how the substitution effect of an increase in the
interest rate influences households’ desired saving.
b. Explain how the income effect of an increase in the
interest rate influences households’ desired saving. Why
does the direction of the income effect depend on
whether the household is a net debtor or a net creditor?
c. Explain why, for the economy as a whole, the substitution
effect is likely to dominate the income effect.
d. What is the importance of the result in part (c) for the
economy’s supply of financial capital?
9. “Profit-maximizing firms will reduce their desired investment
when the interest rate rises, other things being equal. As a result,
empirical economists should always expect to see a negative
