Liquidity Preference Theory: Understanding the Influential Factors Behind Holding Cash in an Economy

The video explores Keynes' liquidity preference theory, which examines why economic agents hold liquidity and how interest rates influence these holdings. It introduces the transactions, precautionary, and speculative motives for holding money. The speculative motive is linked to bond prices and interest rates. The video also explains how the liquidity preference curve interacts with the money supply to determine interest rates, and discusses the concept of a liquidity trap, where interest rate changes become ineffective.

What is the primary focus of the liquidity preference theory?

• To determine the factors influencing liquidity holdings

• To explain the production of goods

• To analyze government spending

• To study international trade

According to Keynes, what is interest primarily a reward for?

• Purchasing bonds

• Investing in stocks

• Sacrificing liquidity

• Saving money

Which of the following is NOT one of the three motives for holding money?

• Speculative motive

• Precautionary motive

• Investment motive

• Transactions motive

How does the transactions motive relate to interest rates?

• It is perfectly interest elastic

• It is perfectly interest inelastic

• It is unrelated to interest rates

• It varies with interest rates

What happens to liquidity preference when interest rates are low?

• It becomes unpredictable

• It increases

• It decreases

• It remains unchanged

What determines the rate of interest in an economy according to the liquidity preference theory?

• The amount of foreign investment

• The interaction of the liquidity preference curve and the supply of money

• The level of government spending

• The rate of inflation

What is the result of an excess demand for money in the market?

• Interest rates fall

• The demand for money decreases

• Interest rates rise

• The supply of money increases

What is a liquidity trap?

• A situation where inflation is uncontrollable

• A situation where money supply is unlimited

• A situation where interest rates are ineffective

• A situation where interest rates are too high

How can central banks respond to changes in liquidity preference to maintain stable interest rates?

• By adjusting tax rates

• By decreasing the money supply

• By controlling inflation

• By increasing the money supply

What does the 0 lower bound refer to in the context of a liquidity trap?

• The minimum level of inflation

• The point where interest rates become ineffective

• The threshold for government spending

• The maximum level of interest rates