Final answer:
If the income effect is greater than the substitution effect, an increase in interest rates typically results in reduced savings as individuals feel wealthier and choose to spend more presently.
Step-by-step explanation:
When the income effect is greater than the substitution effect, an increase in interest rates on savings tends to lead individuals to consume more in the present and save less. Therefore, the correct answer is (d) reduces savings.
An increase in interest rates makes future consumption cheaper relative to present consumption; this is the substitution effect, which would generally increase savings. However, if the income effect is stronger—in other words, the higher interest rate makes a person feel wealthier and influences them to spend more now—the overall result is reduced savings.
In Jonathan's case, if the income effect outweighs the substitution effect, it means that the increase in interest rates will make him feel wealthier now, pushing him towards spending more in the present and saving less for the future. This is a direct consequence of the expected increase in future income due to higher interest rates, prompting a preference for current consumption even though the opportunity cost of not saving is higher.