According to the liquidity preference model, a(n) _ in the money supply shifts the money supply curve to the _ and increases the equilibrium interest rate. decrease; right increase; right decrease; left increase; left
The Correct Answer and Explanation is:
The correct answer is: increase; right.
Explanation:
The liquidity preference model, developed by John Maynard Keynes, is a framework used to explain the relationship between the money supply, interest rates, and the demand for money. In this model, people hold money for three main reasons: transactions, precautionary motives, and speculative purposes. The money market is in equilibrium when the quantity of money supplied equals the quantity of money demanded.
Now, let’s break down the components of the question:
- Increase in the money supply:
When the central bank increases the money supply, it injects more money into the economy. This shift is represented graphically by a rightward shift in the money supply curve. More money is available in the system, meaning there is a higher quantity of money available for transactions or speculative purposes. - Shift of the money supply curve to the right:
When the money supply increases, the money supply curve shifts to the right because at every interest rate, there is now more money available in the economy. This results in a lower interest rate initially because people will have excess money to hold. - Effect on equilibrium interest rate:
With more money available, there is initially downward pressure on interest rates. This is because, as the supply of money increases, the cost of holding money (the interest rate) decreases. However, the question is asking about how the increase in the money supply affects the equilibrium interest rate, which means we are considering the dynamic interactions between supply and demand for money. An increase in the money supply can lead to an increase in the demand for money, especially if there is a corresponding increase in economic activity. If people expect more transactions or speculative demand, the equilibrium interest rate might rise. Essentially, the increase in the money supply shifts the supply curve to the right, and the interest rate adjusts accordingly. However, the exact change in interest rates depends on the relative strength of the shifts in demand and supply.
Thus, an increase in the money supply shifts the money supply curve to the right, and this can increase the equilibrium interest rate under certain conditions.
