This economics question tests your understanding of economic models and analysis. The step-by-step answer below applies the relevant framework and explains the reasoning.
ScanSolve AI Answer
Step 1: Recall components of money demand in liquidity preference theory (Keynes). Money demand M^d = M_t^d + M_p^d + M_s^d, where M_t^d (transactions), M_p^d (precautionary) are active demand (positively related to income Y, insensitive to interest rate i), and M_s^d (speculative) is passive demand (inversely related to i): M_s^d = f(i), ( M_s^d)/( i) < 0. Higher i increases opportunity cost of holding money, so passive demand falls. Step 2: Option A claims positive relationship between interest rate i and passive demand for money (M_s^d). Formula: M_s^d = L_s(i), with ( L_s)/( i) < 0. Substitute observation: As i rises, M_s^d falls. Simplify: Positive relationship is incorrect; it is negative. Step 3: Option B: Liquidity preference theory refers to demand for active and passive balances, determined by need for transactions and keeping wealth in money form. This matches Keynes' theory: active for transactions/precautionary, passive for speculation/wealth. Correct. Step 4: Option C: An increase in income causes demand for money for transactions purposes to increase. Formula: M_t^d = kY, k > 0. Substitute: Y > 0 M_t^d > 0. Correct. Step 5: Option D: Purpose of financial market (money market) model is to explain how interest rate influences demand for money. Money market: M^s = M^d(Y, i), equilibrium sets i. Correct. Step 6: Identify INCORRECT statement. Only A is wrong. A