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What is the theory of liquidity preference How doe it help explain the downward slope of the aggregate-demand curve?

What is the theory of liquidity preference How doe it help explain the downward slope of the aggregate-demand curve?

According to the theory, the aggregate-demand curve slopes downward because: (1) a higher price level raises money demand; (2) higher money demand leads to a higher interest rate; and (3) a higher interest rate reduces the quantity of goods and services demanded.

What is the theory of liquidity preference quizlet?

What is the theory of liquidity preference? The theory is, in essence, an application of supply and demand. According to Keynes, the interest rate adjusts to balance the supply of and demand for money.

Why do we demand money according to liquidity preference theory?

the precautionary motive: people prefer to have liquidity in the case of social unexpected problems that need unusual costs. The amount of money demanded for this purpose increases as income increases. speculative motive: people retain liquidity to speculate that bond prices will fall.

What are the three motives of liquidity preference as given by Keynes explain?

Demand for money: Liquidity preference means the desire of the public to hold cash. According to Keynes, there are three motives behind the desire of the public to hold liquid cash: (1) the transaction motive, (2) the precautionary motive, and (3) the speculative motive.

Why money demand curve is downward sloping by the theory of liquidity preference?

The money demand curve slopes downward in the usual way because, as the interest rate increases, the quantity of money demanded decreases. Equilibrium will be reached because, if the interest rate exceeds the equilibrium rate (i*), the quantity of money demanded will be less than the quantity of money supplied.

What is meant by liquidity preference theory?

Liquidity Preference Theory is a model that suggests that an investor should demand a higher interest rate or premium on securities with long-term maturities that carry greater risk because, all other factors being equal, investors prefer cash or other highly liquid holdings.

Which of the following is true about liquidity preference theory?

Which of the following is true about liquidity preference theory? It is most relevant to the short run of interest rates. the interest rate to rise, so aggregate demand shifts left. The interest-rate effect stems from the idea that a higher price level decreases the real value of households’ money holdings.

What is the concept of liquidity preference?

What are the 3 main motives for holding money?

In The General Theory, Keynes distinguishes between three motives for holding cash ‘(i) the transactions-motive, i.e. the need of cash for the current transaction of personal and business exchanges; (ii) the precautionary-motive, i.e. the desire for security as to the future cash equivalent of a certain proportion of …

What do you mean by liquidity preference?

Liquidity preference, in economics, the premium that wealth holders demand for exchanging ready money or bank deposits for safe, non-liquid assets such as government bonds. The concept of liquidity preference was used by Keynes to explain the prolonged depression of the 1930s.

Which is the best description of the liquidity preference theory?

Liquidity Preference Theory. The Liquidity Preference Theory says that the demand for money is not to borrow money but the desire to remain liquid. In other words, the interest rate is the ‘price’ for money.

How is the multiplier effect related to liquidity preference?

An increase in Money Supply leads to a fall in Interest Rates (the Liquidity Preference Theory denoted by R). This, in turn, leads to higher Investment (Theory of Investment denoted by I) which then results in higher Income (Y) via the Multiplier Effect. Monetarist Liquidity Preference Theory.

How is the short term interest rate determined by liquidity preference?

Keynes called the aggregate demand for money in the economy liquidity preference. According to Keynes General Theory, the short-term interest rate is determined by the supply and demand for money.

Is the LM curve a liquidity preference function?

L (r,Y) is a liquidity preference function if and if , where r is the short-term interest rate and Y is the level of output in the economy. Formally, the liquidity money (LM) curve is the locus of points in Output – Interest Rate space such that the money market is in equilibrium.