 a formal model of consumption and saving, the real interest rate and the consumption saving decision, the real interest rate and the budget line. Dear students, we know that the slope of the budget line is determined by the interest rate. So, any change in interest rate will change the slope of the budget line. So, if interest rate increases, the budget line will become steeper and vice-versa. If it decreases, it will become flatter. But one point important is the budget lines. The change in interest rate will not affect. That point is no barring and no landing point. E point, the budget line in red is the initial budget line. The slope of the budget line is minus 1.10, i.e. 10% interest rate. And the budget line in black is steeper if you compare it with red. And we assume that the interest rate has increased from 10% to 76%. So, it has become steeper. But in both the budget lines, the common point is E. Why is E common? E is the point where the consumer has the resources available in their present period, which resources they have, from income and from wealth. So, the resources they had in the present period were exactly the same as their consumption and present consumption. So, they do not need a barring, nor do they have anything that they can land on. So, if an interest rate changes, then there will be no change in this position. And in the future, what they have will be earned and they will spend there. So, this point is common in both the points. If you focus on the red one, I explained the E point. That point is no barring, no landing point. And despite the change in the interest rate, the new budget line in black will also pass through that point. This point will always be available to them, whatever is the interest rate. Because neither they are borrowing nor they are lending. So, in the interest rate, it will have to make a difference. This point will always remain available to them. And the second thing we want to understand is that if the E point is focused on the red one, if you are at any point above the E point, in the red budget line, you are at any point above the E point, then what does this mean? For example, you are here. This means that this is your current consumption. When you have the current, how many resources were there? 60,000. If the current consumption is less, then this means that you have some savings available that you can deposit in the bank and earn interest on it. So, above all these points of red, the household or individual is doing net saving and because of that saving, they are lending and they are earning the interest rate. And if you have it at any point below the E point, on the red budget line, then that individual is a net borrower. For example, if he is at this point, then he had 60,000 resources, but he is spending more than 60,000 in the current period. How will he do it? He will borrow it. So, if he is at the bottom, then he is a net borrower and if he is above the E, then he is a net lender. And when the interest rate increased, then the budget line came to the black one from red. What is the black one? Actually, it is rotating clockwise. It is getting steeper. What will happen if it gets steeper? You will see that if the interest rate was below the current period, then because he was a net borrower, then because of the increase in the interest rate, now his present value of lifetime resources will decrease. So, from 0.90,000, he came to the left, 78,000 to 750,000. Because he was borrowing from the net borrower. So, that is why he will have less resources than before. And if you go to the vertical axis, then the vertical interest rate has shifted upward. So, by increasing the interest rate, he will be able to earn more interest than before. And in the future, he will have more resources. So, by changing the interest rate, we understood the change in the budget line. Now, we will talk about substitution effect. When the interest rate changes, we have understood theoretically that it will have two types of impact. One is through the substitution effect and the other through the income effect. What will happen because of the substitution effect? Because the interest rate has increased, the interest rate has increased means that his current consumption will be expensive and his future consumption will be relatively cheaper. Today, he saves 1 rupee, so because of the increase in the interest rate in the future, he will be able to consume more. So, his future consumption will be relatively cheaper so that's why he will reduce the current consumption and increase the future consumption. How will he increase his savings? Okay, increasing future consumption and reducing current consumption, increasing savings, this will be the impact of the increase in the interest rate. Suppose, we discuss a case in which the individual has a starting point on which he is neither borrowing nor lending, so what will be the effect of the increase in the interest rate? An increase in the real interest rate if it is at the initial no-borrowing or no-lending point, then in that case, the unambiguously increase in the future consumption of the individual and the current consumption will decrease. We understand this with the help of the diagram. Initially, he started with the e-point, right? This black one was his budget line and the e-point was his. By increasing the interest rate, BL2 shifted to the second budget line. If you compare the second budget line with black, then you will see that when it was on black, then this triangle was available on this triangle. And when you go to red, then in this triangle, now a new triangle from red, which is the boundary determinant, a new triangle will come to it. You can see this triangle in two ways. In this triangle, some areas are decreasing from the black one, this area is decreasing, and this upper area is increasing in its triangle. The meaning of this is that when it was on black, then the things available in this area are not available now, and some more pairs are available in the upper area. So, the e-point will never shift to this downward portion. Why not? Because when he chose the e-point, then he was also available in the downward portion at that time, but he preferred the e-point with all these things. Since the e-point is still available in the new situation, the new equilibrium point from the e-point will not be downward. Why would it be downward? Because it was not available before, but now it is available in the new situation. So, we assume that the e-point is shifting to v. v is the new equilibrium point. How is the new equilibrium point the same definition of equilibrium? Now, the new indifference curve is becoming the tangent of the new budget line at point v. And the new indifference curve, iC2 is higher than iC1. It means that the total utility and total satisfaction of v as compared to e has increased. If you compare e and v, then the current consumption of e was 60,000. 60,000 was the no-barring, no-landing point. If you recall the numerical values, then 42,000 was its current income, 18,000 was its wealth. So, the total 60,000 was available in the current period. So, in the initial position, it was using all its resources in the current period. But now, when it is on v, then its current consumption is less than 60,000 and is 51,000. Why is the consumption less? We have understood this by increasing the interest rate. By increasing the interest rate, the current consumption is now expensive for it. The future consumption is cheap for it. So, it will increase the future consumption by reducing the current consumption. The current consumption has decreased from 60,000 to 51,000. So, the reduction in this, we call it substitution effect. It has substituted the future consumption for the current consumption. So, in its saving, the 60 minus 51 you will do, then it has increased the saving of 9,000. On the 60,000, its saving was zero. And now, on the v-point, it is saving 9,000. Why is it saving? Due to substitution effect. Because of increasing the interest rate, it has an attractive saving. The reward for saving has increased. And the current consumption has become expensive. So, it has reduced the current consumption and increased the saving.