CA Foundation Economics – Understand Money Market Functioning Multiple Choice Questions

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The Concept Of Money Demand Important Theories Introduction

Question 1. What is the concept of money demand in economics?

  1. It refers to the quantity of money supplied by the central bank.
  2. It refers to the desire of individuals and businesses to hold money for transactions and speculative purposes.
  3. It refers to the quantity of money demanded by the government for its expenditures.
  4. It refers to the total money supply in the economy.

Answer: 2. It refers to the desire of individuals and businesses to hold money for transactions and speculative purposes.

Explanation:

The concept of money demand in economics refers to the willingness and desire of individuals and businesses to hold money for various purposes, such as transactions and speculative motives.

Question 2. What does the speculative motive for bolding money suggest?

  1. Individuals hold money to finance their day-to-day expenses.
  2. Individuals hold money as a store of value to preserve wealth.
  3. Individuals hold money to speculate on the future direction of interest rates.
  4. Individuals hold money to invest in financial assets.

Answer: 3. Individuals hold money to speculate on the future direction of interest rates.

Explanation:

The speculative motive for holding money suggests that individuals hold money to take advantage of potential changes in interest rates, anticipating higher returns in the future.

Question 3. Which of the following is NOT a component of the demand for money?

  1. Transaction motive
  2. Speculative motive
  3. Precautionary motive
  4. Investment motive

Answer: 4. Investment motive

Explanation:

The investment motive is not a component of the demand for money. The components of money demand are the transaction motive, speculative motive, and precautionary motive.

Question 4. What is the transaction motive for holding money?

  1. It refers to holding money to speculate on future price changes in financial assets.
  2. It refers to holding money for future investment opportunities.
  3. It refers to holding money to finance day-to-day transactions and purchases.
  4. It refers to holding money to preserve wealth.

Answer: 3. It refers to holding money to finance day-to-day transactions and purchases.

Explanation:

The transaction motive for holding money refers to holding money to facilitate day-to-day transactions and purchases of goods and services.

Question 5. How does an increase in interest rates affect the demand for money?

  1. An increase in interest rates decreases the demand for money.
  2. An increase in interest rates increases the demand for money.
  3. An increase in interest rates has no impact on the demand for money.
  4. An increase in interest rates reduces the money supply.

Answer: 3. An increase in interest rates decreases the demand for money.

Explanation:

An increase in interest rates reduces the attractiveness of holding money, as individuals may prefer to hold interest-bearing financial assets instead. Therefore, an increase in interest rates decreases the demand for money.

Question 6. What are the factors that influence the demand for money in an economy?

  1. The quantity of money supplied by the central bank and the level of government spending.
  2. The level of economic growth and the rate of inflation.
  3. The level of interest rates, the level of income, and the price level.
  4. The quantity of money demanded by consumers and businesses.

Answer: 3. The level of interest rates, the level of income, and the price level.

Explanation:

The demand for money is influenced by the level of interest rates (cost of holding money), the level of income (higher income may lead to higher money demand), and the price level (higher prices may increase the demand for money).

Question 7. Which theory of money demand suggests that people hold money because they prefer liquidity over other assets?

  1. Quantity Theory of Money
  2. Cambridge Cash-Balance Theory
  3. Keynesian Liquidity Preference Theory
  4. Classical Quantity Theory of Money

Answer: 3. Keynesian Liquidity Preference Theory

Explanation:

The Keynesian Liquidity Preference Theory suggests that people hold money because they prefer liquidity (easy access to cash) over other assets. It emphasizes the speculative motive for holding money.

Question 8. According to the Cambridge Cash-Balance Theory, – what is the relationship between the demand for money and the price level?

  1. There is a positive relationship between the demand for money and the price level.
  2. There is a negative relationship between the demand for money and the price level.
  3. There is no relationship between the demand for money and the price level.
  4. The demand for money is influenced by changes in the money supply, not the price level.

Answer: 4. There is a positive relationship between the demand for money and the price level.

Explanation:

According to the Cambridge Cash-Balance Theory, there is a positive relationship between the demand for money and the price level. As prices rise, people need to hold more money to finance their transactions, leading to an increased demand for money.

Question 9. The demand for money arises primarily from its function as a

  1. Store of value
  2. Medium of exchange
  3. Unit of account
  4. Commodity

Answer: 2. Medium of exchange

Question 10. According to the quantity theory of money, the demand for money is directly proportional to

  1. The price level
  2. The rate of inflation
  3. The level of real income
  4. The interest rate

Answer: 3. The level of real income

Question 11. The Keynesian theory of money demand suggests that the demand for money is influenced by

  1. The money supply
  2. The interest rate
  3. Consumer confidence
  4. Government expenditure

Answer: 2. The interest rate

Question 12. The speculative motive for holding money is based on the expectation of

  1. High-interest rates in the future
  2. Low inflation rates
  3. A decrease in the money supply
  4. A rise in asset price

Answer: 1. High interest rates in the future

Question 13. The transaction motive for holding money is related to the need for money to conduct:

  1. Speculative investments
  2. Everyday transactions and payments.
  3. International trade
  4. Long-term savings

Answer: 2. Everyday transactions and payments.

Fiat Money

Question 1. What is fiat money?

  1. Money that has intrinsic value based on its physical properties.
  2. Money that is backed by a commodity, such as gold or silver.
  3. Money that is declared legal tender by the government and has no intrinsic value.
  4. Money that is used for online transactions and digital payments.

Answer: 3. Money that is declared legal tender by the government and has no intrinsic value.

Explanation:

Fiat money is a type of currency that is declared legal tender by the government and is used as a medium of exchange, but it has no intrinsic value and is not backed by any physical commodity.

Question 2. What gives value to fiat money?

  1. Its acceptance by the international community.
  2. It’s backed by a commodity, such as gold.
  3. Its supply and demand in the foreign exchange market.
  4. The trust and confidence of the people in the government and the economy.

Answer: 4. The trust and confidence of the people in the government and the economy.

Explanation:

The value of fiat money is derived from the trust and confidence of the people in the government and the stability of the economy. As long as people have faith in the currency’s acceptance of transactions, it maintains its value.

Question 3. Which of the following statements is true about fiat money?

  1. Fiat money has intrinsic value based on its physical properties.
  2. Fiat money is backed by a commodity, such as gold. ‘
  3. Fiat money is not subject to inflationary pressures.
  4. Fiat money is susceptible to hyperinflation if not properly managed.

Answer: 4. Fiat money is susceptible to hyperinflation if not properly managed.

Explanation:

While fiat money itself does not have intrinsic value, its value can be eroded by excessive money supply and mismanagement by the government or central bank, leading to hyperinflation in extreme cases.

Question 4. What distinguishes fiat money from commodity money?

  1. Commodity money is declared legal tender by the government, while fiat money has intrinsic value.
  2. Commodity money is backed by a commodity, while fiat money has no intrinsic value.
  3. Commodity money is used for online transactions, while fiat money is physical currency.
  4. Commodity money is widely accepted internationally, while fiat money is limited to domestic use.

Answer: 2. Commodity money is backed by a commodity, while fiat money has no intrinsic value.

Explanation:

Commodity money, such as gold or silver, has intrinsic value because it is made of a valuable commodity. On the other hand, fiat money has no intrinsic value and relies solely on the government’s declaration of its legal tender status.

Question 5. How does fiat money facilitate transactions in an economy?

  1. By providing a medium of exchange without any value.
  2. By allowing barter exchanges between goods and services.
  3. By serving as a store of value based on its intrinsic worth.
  4. By acting as a widely accepted medium of exchange with government backing.

Answer: 4. By acting as a widely accepted medium of exchange with government backing.

Explanation:

Fiat money serves as a widely accepted medium of exchange in an economy because the government declares it as legal tender, which provides the necessary trust and confidence for people to use it foi transactions.

Question 6. Which of the following best describes the source of value for fiat money

  1. Its physical properties and rarity.
  2. It’s backed by precious metals, such as gold or silver.
  3. Its acceptance and recognition as a medium of exchange by the government
  4. Its fixed exchange rate with foreign currencies.

Answer: 3. Its acceptance and recognition as a medium of exchange by the government.

Explanation:

The value of fiat money comes from its acceptance and recognition a a medium of exchange by the government, which gives it legal tend* status and ensures its use in transactions.

Question 7. How does the government control the supply of fiat money in the economy?

  1. By printing more money to stimulate economic growth.
  2. By linking the money supply to the country’s foreign exchange reserves.
  3. By adhering to a fixed exchange rate with other countries.
  4. By managing the money supply through monetary policy and central bank actions.

Answer: 4. By managing the money supply through monetary policy and central bank actions.

Explanation:

The government controls the supply of fiat money through monetary policy, which involves actions taken by the central bank to influence interest rates, reserve requirements, and open market operations to manage the money supply and ensure price stability in the economy.

Question 8. What are the advantages of using fiat money as a medium of exchange?

  1. It has intrinsic value based on its physical properties.
  2. It provides a stable and fixed exchange rate with foreign currencies.
  3. It can be easily controlled and managed by the government.
  4. It is not subject to inflationary pressures.

Answer: 3. It can be easily controlled and managed by the government.

Explanation:

One of the advantages of using fiat money is that it can be easily controlled and managed by the government and central bank through monetary policy, allowing them to respond to economic conditions and maintain stability.

The Demand For Money

Question 1. What does the demand for money refer to in economics?

  1. The total amount of money in circulation in the economy.
  2. The desire of individuals and businesses to hold money for various purposes.
  3. The quantity of money supplied by the central bank
  4. The amount of money demanded by the government for its expenditures.

Answer: 2. The desire of individuals and businesses to hold money for various purposes

Explanation:

The demand for money in economics refers to the desire of individuals and businesses to hold money for -various purposes, such as transactions, precautionary motives, and speculative motives.

Question 2. Which of the following is NOT a motive for holding money?

  1. Transaction motive
  2. Precautionary motive
  3. Speculative motive
  4. Investment motive

Answer: 4. Investment motive.

Explanation:

The investment motive is not a motive for holding money. The three primary motives for holding money are the transaction motive, precautionary motive, and speculative motive.

Question 3. What is the transaction motive for holding money?

  1. It refers to holding money for future investment opportunities.
  2. It refers to holding money to speculate on future price changes in financial assets.
  3. It refers to holding money to finance day-to-day transactions and purchases.
  4. It refers to holding money to preserve wealth.

Answer: 3. It refers to holding money to finance day-to-day transactions and purchases.

Explanation:

The transaction motive for holding money refers to holding money to facilitate day-to-day transactions and purchases of goods and services.

Question 4. How does an increase in interest rates affect the demand for money?

  1. An increase in interest rates decreases the demand for money.
  2. An increase in interest rates increases the demand for money.
  3. An increase in interest rates has no impact on the demand for money.
  4. An increase in interest rates reduces the money supply.

Answer: 2. An increase in interest rates decreases the demand for money.

Explanation:

An increase in interest rates reduces the attractiveness of holding money, as individuals may prefer to hold interest-bearing financial assets instead. Therefore, an increase in interest rates decreases the demand for money.

Question 5. Which theory of money demand suggests that people hold money because they prefer liquidity over other assets?

  1. Quantity Theory of Money
  2. Cambridge Cash-Balance Theory
  3. Keynesian Liquidity Preference Theory
  4. Classical Quantity Theory of Money

Answer: 3. Keynesian Liquidity Preference Theory

Explanation:

The Keynesian Liquidity Preference Theory suggests that people hold money because they prefer liquidity (easy access to cash) over other assets. It emphasizes the speculative motive for holding money.

Question 6. According to the Cambridge Cash-Balance Theory, what is the relationship between the demand for money and the price level?

  1. There is a positive relationship between the demand for money and the price level.
  2. There is a negative relationship between the demand for money and the price level.
  3. There is no relationship between the demand for money and the price level.
  4. The demand for money is influenced by changes in the money supply, not the price level.

Answer: 1. There is a positive relationship between the demand for money and the price level.

Explanation:

According to the Cambridge Cash-Balance Theory, there is a positive relationship between the demand for money and the price level. As prices rise, people need to hold more money to finance their transactions, leading to an increased demand for money.

Question 7. Which theory of money demand suggests that the demand for money depends on the interest rate and the level of income?

  1. Quantity Theory of Money
  2. Classical Quantity Theory of Money
  3. Keynesian Liquidity Preference Theory
  4. Cambridge Cash-Balance Theory

Answer: 4. Cambridge Cash-Balance Theory

Explanation:

The Cambridge Cash-Balance Theory suggests that the demand for money depends on the interest rate and the level of income. As income increases, the demand for money increases, and as the interest rate rises, the demand for money decreases.

Question 8. What is the speculative motive for holding money?

  1. It refers to holding money for future investment opportunities.
  2. It refers to holding money to speculate on future price changes in financial assets.
  3. It refers to holding money to finance day-to-day transactions and purchases.
  4. It refers to holding money to preserve wealth. –

Answer: 2. It refers to holding money to speculate on future price changes in financial assets.

Explanation:

The speculative motive for holding money refers to holding money with the expectation of taking advantage of potential changes in asset prices, especially in financial markets.

Question 9. The demand for money is a function of

  1. The money supply
  2. The interest rate
  3. The inflation rate
  4. All of the above

Answer: 4. All of the above

Question 10. The demand for money for transactions is influenced by

  1. Future expectations of interest rates
  2. Consumer preferences for holding money
  3. The level of income and economic activity
  4. Speculative investments

Answer: 3. The level of income and economic activity

Question 11. The precautionary motive for holding money arises from the need to

  1. Conduct day-to-day transactions
  2. Make speculative investments
  3. Save for future emergencies and uncertainties
  4. Avoid inflation

Answer: 3. Save for future emergencies and uncertainties

Question 12. According to the Keynesian theory, an increase in the interest rate will lead to

  1. An increase in the demand for money
  2. A decrease in the demand for money
  3. No change in the demand for money
  4. An increase in the money supply

Answer: 2. A decrease in the demand for money

Question 13. The speculative motive for holding money is driven by expectations of

  1. High inflation rates
  2. Low-interest rates in the future
  3. A decrease in the money supply
  4. Economic stability

Answer: 2. Low interest rates in the future

Theories Of Demand For Money

Question 1. Which theory of demand for money suggests that people hold money transactions, with precautionary, and speculative motives?

  1. Classical Quantity Theory of Money
  2. Keynesian Liquidity Preference Theory
  3. Cambridge Cash-Balance Theory
  4. Quantity Theory of Money

Answer: 2. Keynesian Liquidity Preference Theory

Explanation:

The Keynesian Liquidity Preference Theory proposes that people hold money for three motives:

  1. Transactions
  2. Precautionary, and
  3. Speculative motives.

Question 2. According to the Keynesian Liquidity Preference Theory, what determines the demand for money?

  1. The price level and the level of income in the economy.
  2. The interest rate and the level of investment in the economy.
  3. The rate of inflation and the government’s fiscal policy.
  4. The exchange rate and the country’s foreign trade.

Answer: 1. The price level and the level of income in the economy.

Explanation:

According to the Keynesian Liquidity Preference Theory, the demand for money is influenced by the price level and the level of income in the economy.

Question 3. Which theory of demand for money suggests that people hold money to take advantage of potential changes in interest rates?

  1. Cambridge Cash-Balance Theory
  2. Quantity Theory of Money
  3. Classical Quantity Theory of Money
  4. Keynesian Liquidity Preference Theory

Answer: 1. Cambridge Cash-Balance Theory

Explanation:

The Cambridge Cash-Balance Theory suggests that people hold money to take advantage of potential changes in interest rates, especially in financial markets.

Question 4. According to the Cambridge Cash-Balance Theory, what is the relationship between the demand for money and the interest rate?

  1. There is a positive relationship between the demand for money and the interest rate.
  2. There is a negative relationship between the demand for money and the interest rate.
  3. There is no relationship between the demand for money and the interest rate.
  4. The demand for money is solely determined by changes in the money supply.

Answer: 2. There is a negative relationship between the demand for money and the interest rate.

Explanation:

According to the Cambridge Cash-Balance Theory, there is a negative relationship between the demand for money and the interest rate. As interest rates increase, the opportunity cost of holding money rises, leading to a lower demand for money.

Question 5. Which theory of demand for money focuses on the long-run relationship between money demand and income?

  1. Keynesian Liquidity Preference Theory
  2. Quantity Theory of Money
  3. Classical Quantity Theory of Money
  4. Cambridge Cash-Balance Theory

Answer: 2. Quantity Theory of Money

Explanation:

The Quantity Theory of Money focuses on the long-run relationship between money demand and income, suggesting that the demand for money is directly proportional to the level of income in the economy.

Question 6. What does the Quantity Theory of Money state about the demand for money about income?

  1. The demand for money is inversely proportional to the level of income.
  2. The demand for money is directly proportional to the level of income.
  3. The demand for money is unrelated to the level of income.
  4. The demand for money is determined solely by the interest rate.

Answer: 2. The demand for money is directly proportional to the level of income.

Explanation:

The Quantity Theory of Money states that the demand for money is directly proportional to the level of income in the economy.

Question 7. According to the Classical Quantity Theory of Money, what is the primary determinant of the demand for money?

  1. The interest rate in the economy.
  2. The price level and the level of income.
  3. The level of government spending and taxation.
  4. The supply of money by the central bank.

Answer: 2. The price level and the level of income.

Explanation:

According to the Classical Quantity Theory of Money, the primary determinants of the demand for money are the price level and the level of income in the economy.

Question 8. What is the central proposition of the Classical Quantity Theory of Money?

  1. An increase in the money supply leads to a proportional increase in . prices.
  2. An increase in the money supply leads to a proportional decrease in prices.
  3. An increase in the money supply leads to a proportional increase in output and income.
  4. An increase in the money supply has no impact on the economy.

Answer: 1. An increase in the money supply leads to a proportional increase in prices.

Explanation:

The central proposition of the Classical Quantity Theory of Money is that an increase in the money supply while holding other factors constant, leads to a proportional increase in the price level in the economy. This is often expressed as the equation MV = PT, where M is the money supply, V is the velocity of money, P is the price level, and T is the level of transactions in the economy.

Question 9. The classical quantity theory of money suggests that the demand for money is primarily influenced by

  1. The interest rate
  2. The level of income
  3. Future expectations of inflation
  4. Government policies

Answer: 2. The level of income

Question 10. According to the Keynesian theory of money demand, the demand for money is mainly influenced by

  1. The interest rate
  2. The level of income and economic activity
  3. Future expectations of inflation
  4. Government expenditure

Answer: 1. The interest rate

Question 11. The speculative demand for money is based on the expectation of

  1. High-interest rates in the future
  2. Low inflation rates
  3. A decrease in the money supply
  4. High economic growth

Answer: 1. High interest rates in the future

Question 12. The precautionary demand for money arises due to the need to hold money

  1. Everyday transactions
  2. Speculative investments
  3. Emergency purposes and uncertainties
  4. Tax payments

Answer: 3. Emergency purposes and uncertainties

Question 13. The “Baumol-Tobin model” of money demand suggests that people will try to minimize the

  1. The opportunity cost of holding money
  2. Inflation rate
  3. Government intervention in the economy
  4. Transaction costs of converting assets into money

Answer: 1. The opportunity cost of holding money

Classical Approach: The Quantity Theory Of Money (QTM)

Question 1. According to the Classical Quantity Theory of Money (QTM), what is the primary determinant of the price level in an economy?

  1. The level of income and output.
  2. The quantity of money in circulation.
  3. The interest rate is set by the central bank.
  4. The level of government spending.

Answer: 2. The quantity of money in circulation.

Explanation:

According to the Classical Quantity Theory of Money, the primary determinant of the price level in an economy is the quantity of money in circulation. An increase in the money supply, assuming all other factors remain constant, leads to a proportional increase in prices.

Question 2. The Classical Quantity Theory of Money (QTM) assumes which of the following?

  1. Stable velocity of money.
  2. Variable money demand.
  3. The inverse relationship between money supply and price level.
  4. Constant level of economic output.

Answer: 1. Stable velocity of money.

Explanation:

The Classical Quantity Theory of Money assumes a stable velocity of money, meaning that the rate at which money circulates in the economy remains relatively constant over time. This assumption is necessary for the theory’s central proposition.

Question 3. According to the Classical Quantity Theory of Money (QTM), what happens if the money supply increases while other factors remain unchanged? ,

  1. Prices and output will both increase proportionally.
  2. Prices will increase proportionally, but output remains unchanged.
  3. Output will increase proportionally, but prices remain unchanged.
  4. Prices and output will both remain unchanged.

Answer: 2. Prices will increase proportionally, but output remains unchanged.

Explanation:

According to the Classical Quantity Theory of Money, if the money supply increases while other factors, such as the level of output and velocity of money, remain unchanged, prices will increase proportionally. However, the theory does not posit any direct impact on the level of economic output.

Question 4. How does the Classical Quantity Theory of Money (QTM) view the relationship between money supply and inflation?

  1. An increase in the money supply leads to deflation.
  2. An increase in the money supply has no impact on inflation.
  3. An increase in the money supply leads to inflation.
  4. An increase in the money supply leads to stagflation.

Answer: 3. An increase in the money supply leads to inflation.

Explanation:

The Classical Quantity Theory of Money posits that an increase in the money supply, assuming a stable velocity of money, leads to a proportional increase in the price level, resulting in inflation.

Question 5. What does the equation MV = PT represent in the context of the Classical Quantity Theory of Money (QTM)?

  1. The relationship between money supply and interest rates.
  2. The relationship between money supply and economic output.
  3. The relationship between money supply and the price level.
  4. The relationship between money supply and the velocity of money.

Answer: 3. The relationship between money supply and the price level.

Explanation:

The equation MV = PT represents the relationship between the money supply (M), the velocity of money (V), the price level (P), and the level of transactions (T) in the economy according to the Classical Quantity Theory of Money.

Question 6. How does the Classical Quantity Theory of Money (QTM) view the long-run relationship between money supply and economic growth?

  1. An increase in the money supply leads to sustainable economic growth.
  2. An increase in the money supply has no impact on economic growth.
  3. An increase in the money supply leads to temporary economic growth, followed by contraction.
  4. An increase in the money supply leads to short-run economic growth, followed by inflation.

Answer: 2. An increase in the money supply has no impact on economic growth.

Explanation:

The Classical Quantity Theory of Money suggests that changes in the money supply do not have a long-run impact on economic growth. In the long run, changes in the money supply primarily influence the price level and not the level of economic output.

Question 7. According to the Classical Quantity Theory of Money (QTM), what happens if the money supply increases more rapidly than the growth rate of real output?

  1. Inflation will occur
  2. Deflation will occur
  3. There will be no impact on the economy.
  4. The velocity of money will increase.

Answer: 1. Inflation will occur.

Explanation:

According to the Classical Quantity Theory of Money, if the money supply increases more rapidly than the growth rate of real output (economic production), inflation will occur as there is a higher amount of money chasing the same amount of goods and services.

Question 8. How does the Classical Quantity Theory of Money (QTM) view the role of monetary policy in managing the economy?

  1. Monetary policy can control inflation but has no impact on output.
  2. Monetary policy can control output but has no impact on inflation.
  3. Monetary policy can control both inflation and output.
  4. Monetary policy is ineffective in managing the economy.

Answer: 1. Monetary policy can control inflation but has no impact on output.

Explanation:

According to the Classical Quantity Theory of Money, monetary policy primarily influences the price level (inflation) through changes in the money supply. However, it is generally believed that monetary policy has a limited impact on the level of output or economic growth in the long run.

The Cambridge approach

Question 1. What is the Cambridge Approach in the context of the demand for money?

  1. It is a theory that focuses on the speculative motive for holding money.
  2. It is a theory that emphasizes the transaction motive for holding money.
  3. It is a theory that considers both the transaction and speculative motives for holding money.
  4. It is a theory that rejects the relevance of money demand in the economy.

Answer: 3. It is a theory that considers both the transaction and speculative motives for holding money.

Explanation:

The Cambridge Approach is a theory that combines both the transaction and speculative motives for holding money. It was developed to provide a more comprehensive understanding of the demand for money.

Question 2. According to the Cambridge Approach, what is the key factor that influences the demand for money?

  1. The interest rate is set by the central bank.
  2. The price level and the level of income in the economy.
  3. The rate of inflation and the level of government spending.
  4. The exchange rate and the country’s foreign trade.

Answer: 2. The price level and the level of income in the economy.

Explanation:

According to the Cambridge Approach, the demand for money is influenced by the price level and the level of income in the economy. As prices and income rise, the demand for money for transactions also increases.

Question 3. How does the Cambridge Approach view the relationship between the demand for money and the interest rate?

  1. There is a positive relationship between the demand for money and the interest rate.
  2. There is a negative relationship between the demand for money and, the interest rate.
  3. There is no relationship between the demand for money and the interest rate.
  4. The demand for money is solely determined by changes in the money supply.

Answer: 2. There is a negative relationship between the demand for money and the interest rate.

Explanation:

According to the Cambridge Approach, the demand for money is influenced by the price level and the level of income in the economy. As prices and income rise, the demand for money for transactions also increases.

Question 4. What does the Cambridge Equation, Md = kPY, represent?

  1. The demand for money (Md) is equal to the price level (P) multiplied by the income level (Y).
  2. The demand for money (Md) is equal to the money supply (M) multiplied by the velocity of money (V). v
  3. The demand for money (Md) is equal to the interest rate (r) divided by the price level (P)
  4. The demand for money (Md) is equal to the level of government spending (G) divided by the price level (P).

Answer: 1. The demand for money (Md) is equal to the price level (P) multiplied by the income level (Y).

Explanation:

The Cambridge Equation, Md = kPY, represents the demand for money (Md) as a function of the price level (P) multiplied by the income level (Y), where ‘k’ is a constant representing the proportion of income held as money.

Question 5. What does the parameter ‘k1 in the Cambridge Equation Md = kPY signify?

  1. The money supply in the economy.
  2. The velocity of money.
  3. The interest rate is set by the central bank.
  4. The proportion of income held as money.

Answer: 4. The proportion of income held as money.

Explanation:

In the Cambridge Equation Md = kPY, ‘k’ represents the proportion of income (Y) that people choose to hold as money (Md).

Question 6. According to the Cambridge Approach, how does an increase in income affect the demand for money?

  1. An increase in income leads to a decrease in the demand for money.
  2. An increase in income has no impact on the demand for money.
  3. An increase in income leads to an increase in the demand for money.
  4. An increase in income leads to a shift from speculative to transaction motive for holding money.

Answer: 3. An increase in income leads to an increase in the demand for money.

Explanation:

According to the Cambridge Approach, an increase in income leads to an increase in the demand for money for transactions, as people need more money to finance their increased spending.

Question 7. What does the speculative motive for holding money refer to in the Cambridge Approach?

  1. Holding money to finance day-to-day transactions.
  2. Holding money to take advantage of potential changes in interest rates.
  3. Holding money to preserve wealth and protect against uncertainties.
  4. Holding money to finance future investment opportunities.

Answer: 3. Holding money to preserve wealth and protect against uncertainties.

Explanation:

In the Cambridge Approach, the speculative motive for holding money refers to holding money to preserve wealth and protect against- uncertainties in financial markets.

Question 8. How does the Cambridge Approach view the relationship between the demand for money and the price level?

  1. There is a positive relationship between the demand for money and the price level
  2. There is a negative relationship between the demand for money and the price level.
  3. There is no relationship between the demand for money and the price level.
  4. The demand for money is solely determined by changes in the money supply.

Answer:  1. There is a positive relationship between the demand for money and the price level.

Explanation:

According to the Cambridge Approach, there is a positive relationship between the demand for money and the price level. As prices rise, people need to hold more money for transactions, leading to an increased demand for money.

The Keynesian Theory Of Demand For Money

Question 1. According to the Keynesian Theory of Demand for Money, what are the primary motives for holding money?

  1. Transaction motive and speculative motive.
  2. Precautionary motive and speculative motive.
  3. Transaction motive and precautionary motive.
  4. Transaction motive, precautionary motive, and speculative motive.

Answer: 1. Transaction motive, precautionary motive, and speculative motive.

Explanation:

According to the Keynesian Theory of Demand for Money, individuals hold money for three primary motives: the transaction motive (to carry out day-to-day transactions), the precautionary motive (to meet unexpected expenses or emergencies), and the speculative motive (to take advantage of potential changes in the value of financial assets).

Question 2. What does the transaction motive for holding money refer to in the Keynesian Theory?

  1. Holding money for future investment opportunities.
  2. Holding money to speculate on future price changes in financial assets.
  3. Holding money to preserve wealth and protect against uncertainties.
  4. Holding money to finance day-to-day transactions and purchases.

Answer: 4. Holding money to finance day-to-day transactions and purchases.

Explanation:

In the Keynesian Theory of Demand for Money, the transaction motive refers to holding money to finance day-to-day transactions and purchases of goods and services.

Question 3. According to the Keynesian Theory of Demand for Money, what happens to the demand for money if there is an increase in income?

  1. The demand for money increases.
  2. The demand for money decreases.
  3. The demand for money remains unchanged.
  4. The demand for money is determined solely by changes in the money supply.

Answer: 1. The demand for money increases.

Explanation:

According to the Keynesian Theory of Demand for Money, an increase in income leads to an increase in the demand for money. As income rises, people require more money to facilitate their increased spending.

Question 4. How does the Keynesian Theory of Demand for Money view the relationship between the demand for money and the interest rate?

  1. There is a positive relationship between the demand for money and the interest rate.
  2. There is a negative relationship between the demand for money and the interest rate.
  3. There is no relationship between the demand for money and the interest rate.
  4. The demand for money is solely determined by changes in the money supply.

Answer: 2. There is a negative relationship between the demand for money and the interest rate.

Explanation:

In the Keynesian Theory of Demand for Money, there is a negative relationship between the demand for money and the interest rate. As the interest rate increases, the opportunity cost of holding money rises, leading to a decrease in the demand for money.

Question 5. How does the Keynesian Theory of Demand for Money explain the preference for holding money in liquid form?

  1. People prefer to hold money as it generates interest income.
  2. People prefer to hold money to preserve wealth.
  3. People prefer to hold money for speculative purposes.
  4. People prefer to hold money to avoid the risk of illiquidity.

Answer: 4. People prefer to hold money to avoid the risk of illiquidity.

Explanation:

The Keynesian Theory of Demand for Money explains that people prefer to hold money in liquid form to avoid the risk of illiquidity, meaning they want easy access to cash to meet unexpected expenses or emergencies.

Question 6. What does the speculative motive for holding money refer to in the Keynesian Theory?

  1. Holding money for future investment opportunities.
  2. Holding money to speculate on future price changes in financial assets.
  3. Holding money to preserve wealth and protect against uncertainties.
  4. Holding money to finance day-to-day transactions and purchases.

Answer: 2. Holding money to speculate on future price changes in financial assets.

Explanation:

In the Keynesian Theory of Demand for Money, the speculative motive refers to holding money with the expectation of taking advantage of potential changes in the value of financial assets, especially in financial markets.

Question 7. How does the Keynesian Theory of Demand for Money view the role of interest rates in influencing investment decisions?

  1. Interest rates have no impact on investment decisions
  2. Lower interest rates stimulate more investment.
  3. Higher interest rates stimulate more investment.
  4. Investment decisions are solely based on the level of income.

Answer: 2. Lower interest rates stimulate more investment.

Explanation:

The Keynesian Theory of Demand for Money suggests that lower interest rates stimulate more investment by reducing the opportunity cost of holding money. Lower interest rates make borrowing cheaper, encouraging businesses to undertake more investment projects.

Question 8. According to the Keynesian Theory of Demand for Money, how does an increase in liquidity preference affect the demand for money?

  1. The demand for money increases.
  2. The demand for money decreases.
  3. The demand for money remains unchanged.
  4. The demand for money is solely determined by changes in the money supply.

Answer: 1. The demand for money increases.

Explanation: 

According to the Keynesian Theory of Demand for Money, an increase in liquidity preference (the desire to hold money in liquid form) leads to an increase in the demand for money. This may happen during periods of economic uncertainty or when people become more cautious about spending.

The Transactions Motive

Question 1. What does the “Transactions Motive” for holding money refer to?

  1. Holding money to preserve wealth and protect against uncertainties.
  2. Holding money to take advantage of potential changes in the value of financial assets.
  3. Holding money for speculative purposes.
  4. Holding money to finance day-to-day transactions and purchases.

Answer: 4. Holding money to finance day-to-day transactions and purchases.

Explanation:

The “Transactions Motive” for holding money refers to the primary reason individuals hold money, which is to facilitate day-to-day transactions and make purchases of goods and services.

Question 2. According to the Transactions Motive, what happens to the demand for money when the frequency of transactions increases? 

  1. The demand for money decreases.
  2. The demand for money increases.
  3. The demand for money remains unchanged.
  4. The demand for money is solely determined by changes in the money supply.

Answer: 2. The demand for money increases.

Explanation:

According to the Transactions Motive, when the frequency of transactions increases, individuals require more money to carry out these transactions, leading to an increase in the demand for money.

Question 3. How does the Transactions Motive explain the need for holding money in liquid form?

  1. People prefer to hold money as it generates interest income.
  2. People prefer to hold money to preserve wealth. .
  3. People prefer to hold money for speculative purposes.
  4. People prefer to hold money to avoid the risk of illiquidity.

Answer: 4. People prefer to hold money to avoid the risk of illiquidity.

Explanation:

The Transactions Motive explains that people prefer to hold money in liquid form to avoid the risk of illiquidity. Liquid money can be easily used for day-to-day transactions and is readily accessible.

Question 4. Which of the following situations would lead to an increase in the demand for money due to the transaction motive?

  1. A decrease in the level of economic activity.
  2. An increase in the use of credit cards for transactions.
  3. A decrease in the price level.
  4. An increase in the interest rates.

Answer: 2. An increase in the use of credit cards for transactions.

Explanation:

An increase in the use of credit cards for transactions would likely reduce the demand for physical cash (money) for day-to-day transactions. As a result, the demand for money due to the transaction motive would decrease.

Question 5. How does the transaction motive influence the velocity of money in an economy?

  1. It increases the velocity of money.
  2. It decreases the velocity of money.
  3. It has no impact on the velocity of money.
  4. It leads to unpredictable changes in the velocity of money.

Answer: 1. It increases the velocity of money.

Explanation:

The Transactions Motive encourages the frequent use of money for day-to-day transactions, leading to a higher velocity of money. The velocity of money refers to the rate at which money changes hands in the economy during a specific period.

Question 6. According to the Transactions Motive, how does the level of economic activity affect the demand for money?

  1. An increase in economic activity leads to an increase in the demand for money.
  2. An increase in economic activity leads to a decrease in the demand for money.
  3. The level of economic activity has no impact on the demand for money.
  4. The demand for money is solely determined by changes in the money supply.

Answer: 1. An increase in economic activity leads to an increase in the demand for money.

Explanation:

According to the Transactions Motive, an increase in economic activity leads to an increase in the demand for money as more transactions take place, requiring a larger amount of money to facilitate those transactions.

Question 7. Which of the following is an example of the Transactions Motive for holding money?

  1. Investing in stocks to earn capital gains. ’ ‘
  2. Keeping money in a savings account to earn interest.
  3. Holding cash to pay for groceries and daily expenses.
  4. Speculating on the future price of gold.

Answer: 3. Holding cash to pay for groceries and daily expenses.

Explanation:

The example of holding cash to pay for groceries and daily expenses is consistent with the Transactions Motive, as it involves using money for day-to-day transactions.

Question 8. How does the transaction motive relate to the demand for money during periods of economic expansion?

  1. The demand for money decreases during economic expansion.
  2. The demand for money remains constant during economic expansion.
  3. The demand for money increases during economic expansion.
  4. The demand for money is not influenced by economic expansion. ‘

Answer: 1. The demand for money increases during economic expansion.

Explanation:

During economic expansion, the frequency of transactions and economic activities typically increases. As a result, the transaction motive leads to an increase in the demand for money to facilitate these additional transactions.

The Precautionary Motive

Question 1. What does the “Precautionary Motive” for holding money refer to?

  1. Holding money to preserve wealth and protect against uncertainties.
  2. Holding money to take advantage of potential changes in the value of financial assets.
  3. Holding money for speculative purposes.
  4. Holding money to finance day-to-day transactions and purchases.

Answer: 1. Holding money to preserve wealth and protect against uncertainties.

Explanation:

The “Precautionary Motive” for holding money refers to the desire of individuals to hold money as a precautionary measure against unforeseen expenses or emergencies. It serves as a form of financial buffer or insurance.

Question 2. According to the Precautionary Motive, what happens to the demand for money when individuals become more risk-averse?

  1. The demand for money increases.
  2. The demand for money decreases.
  3. The demand for money remains unchanged.
  4. The demand for money is solely determined by changes in the money supply.

Answer: 1. The demand for money increases.

Explanation:

According to the Precautionary Motive, when individuals become more risk-averse (more cautious about uncertainties), they tend to hold more money as a safety net to handle unexpected expenses. As a result, the demand for money increases.

Question 3. How does the Precautionary Motive explain the preference for holding money in liquid form?

  1. People prefer to hold money as it generates interest income.
  2. People prefer to hold money to preserve wealth.
  3. People prefer to hold money for speculative purposes.
  4. People prefer to hold money to avoid the risk of illiquidity.

Answer: 4. People prefer to hold money to avoid the risk of illiquidity.

Explanation:

The Precautionary Motive explains that people prefer to hold money in liquid form to avoid the risk of illiquidity. Liquid money can be easily accessed and used to meet unexpected expenses or emergencies.

Question 4. Which of the following situations would lead to an increase in the demand for money due to the Precautionary Motive?

  1. A decrease in the level of economic uncertainty.
  2. An increase in the availability of credit facilities.
  3. An increase in disposable income.
  4. An increase in economic stability.

Answer: 2. An increase in the availability of credit facilities.

Explanation:

An increase in the availability of credit facilities provides individuals with an alternative source of funds to handle unexpected expenses. As a result, the demand for money due to the Precautionary Motive decreases.

Question 5. How does the Precautionary Motive influence the allocation of wealth between money and other financial assets?

  1. It encourages a higher allocation of wealth to money.
  2. It encourages a lower allocation of wealth to money.
  3. It has no impact on the allocation of wealth. .
  4. It leads to unpredictable changes in wealth allocation.

Answer: 1. It encourages a higher allocation of wealth to money.

Explanation:

The Precautionary Motive encourages individuals to hold a higher proportion of their wealth in the form of money to serve as a financial cushion in case of emergencies or unexpected expenses.

Question 6. According to the Precautionary Motive, how does the level of economic uncertainty affect the demand for money?

  1. An increase in economic uncertainty leads to an increase in the demand for money.
  2. An increase in economic uncertainty leads to a decrease in the demand for money.
  3. The level of economic uncertainty has no impact on the demand for money.
  4. The demand for money is solely determined by changes in the money supply.

Answer: 1. An increase in economic uncertainty leads to an increase in the demand for money.

Explanation:

According to the Precautionary Motive, an increase in economic uncertainty leads to an increase in the demand for money as individuals become more cautious and prefer to hold more liquid assets to handle uncertainties.

Question 7. Which of the following is an example of the Precautionary Motive for holding money?

  1. Investing in stocks to earn capital gains.
  2. Keeping money in a savings account to earn interest.
  3. Holding cash for emergency medical expenses.
  4. Speculating on the future price of gold.

Answer: 3. Holding cash for emergency medical expenses.

Explanation:

The example of holding cash for emergency medical expenses aligns with the Precautionary Motive, as it involves holding money to handle unforeseen expenses or emergencies.

Question 8. How does the Precautionary Motive relate to the demand for money during periods of economic uncertainty?

  1. The demand for money decreases during economic uncertainty.
  2. The demand for money remains constant during economic uncertainty.
  3. The demand for money increases during economic uncertainty.
  4. The demand for money is not influenced by economic uncertainty.

Answer: 2. The demand for money increases during economic uncertainty.

Explanation:

During periods of economic uncertainty, the Precautionary Motive becomes more pronounced, leading to an increase in the demand for money as individuals seek to hold more liquid assets to cope with potential financial risks and uncertainties.

The Speculative Demand For Money

Question 1. What does the “Speculative Demand for Money” refer to?

  1. Holding money to preserve wealth and protect against uncertainties.
  2. Holding money to take advantage of potential changes in the value of financial assets.
  3. Holding money for day-to-day transactions and purchases.
  4. Holding money to avoid the risk of illiquidity.

Answer: 2. Holding money to take advantage of potential changes in the value of financial assets.

Explanation:

The “Speculative Demand for Money” refers to holding money with the expectation of taking advantage of potential changes in the value of financial assets, especially in financial markets.

Question 2. According to the Speculative Demand for Money, what happens to the demand for money when individuals expect interest rates to rise in the future?

  1. The demand for money increases.
  2. The demand for. money decreases.
  3. The demand for money remains unchanged.
  4. The demand for money is solely determined by changes in the . money supply.

Answer: 2. The demand for money decreases.

Explanation:

According to the Speculative Demand for Money, when individuals expect interest rates to rise in the future, they may choose to hold less money and invest in interest-earning assets to capitalize on higher returns. As a result, the demand for money decreases.

Question 3. How does the Speculative Demand for Money explain the preference for holding money in liquid form?

  1. People prefer to hold money as it generates interest income.
  2. People prefer to hold money to preserve wealth.
  3. People prefer to hold money for speculative purposes.
  4. People prefer to hold money to avoid the risk of illiquidity.

Answer: 3. People prefer to hold money for speculative purposes.

Explanation:

The Speculative Demand for Money explains that people hold money for speculative purposes, expecting to take advantage of potential changes in the value of financial assets. Liquid money can be easily converted into other assets when favorable investment opportunities arise.

Question 4. Which of the following situations would lead to an increase in the demand for money due to the Speculative Demand for Money?

  1. Expectations of a decrease in interest rates.
  2. Expectations of a decrease in the value of financial assets.
  3. Expectations of a decrease in inflation.
  4. Expectations of an economic boom.

Answer: 2. Expectations of a decrease in the value of financial assets.

Explanation:

When individuals expect a decrease in the value of financial assets, they may prefer to hold more money and reduce investments in those assets. This would lead to an increase in the demand for money due to the Speculative Demand for Money

Question 5. How does the Speculative Demand for Money influence the allocation of wealth between money and other financial assets?

  1. It encourages a higher allocation of wealth to money.
  2. It encourages a lower allocation of wealth to money.
  3. It has no impact on the allocation of wealth.
  4. It leads to unpredictable changes in wealth allocation.

Answer: 1. It encourages a higher allocation of wealth to money.

Explanation:

The Speculative Demand for Money encourages individuals to hold a higher proportion of their wealth in the form of money as they wait for favorable investment opportunities. This results in a higher allocation of wealth to money.

Question 6. According to the Speculative Demand for Money, how does the level of confidence in financial markets affect the demand for money?

  1. An increase in confidence leads to an increase in the demand for money.
  2. An increase in confidence leads to a decrease in the demand for money.
  3. The level of confidence has no impact on the demand for money.
  4. The demand for money is solely determined by changes in the money supply.

Answer: 2. An increase in confidence leads to a decrease in the demand for money.

Explanation:

According to the Speculative Demand for Money, an increase in confidence in financial markets makes individuals more willing to invest and hold fewer liquid assets. As a result, the demand for money decreases.

Question 7. Which of the following is an example of the Speculative Demand for Money?’

  1. Investing in a high-interest savings account.
  2. Holding cash for emergency medical expenses
  3. Holding money in anticipation of a stock market rally.
  4. Keeping money in a checking account for day-to-day expenses.

Answer: 3. Holding money in anticipation of a stock market rally.

Explanation:

The example of holding money in anticipation of a stock market rally aligns with the Speculative Demand for Money, as it involves holding money with the expectation of capitalizing on potential increases in the value of financial assets.

Question 8. How does the Speculative Demand for Money relate to the demand for money during periods of economic optimism?

  1. The demand for money decreases during economic optimism.
  2. The demand for money remains constant during economic optimism.
  3. The demand for money increases during economic optimism.
  4. The demand for money is not influenced by economic optimism.

Answer: 1. The demand for money decreases during economic optimism.

Explanation:

During periods of economic optimism, individuals are more willing to invest in financial assets, reducing the demand for holding money for speculative purposes. This leads to a decrease in the Speculative Demand for Money.

Post-Keynesian Developments In The Theory Of Demand For Money

Question 1. What are the key post-Keynesian developments in the theory of demand for money?

  1. Quantity Theory of Money and Fisher’s Equation of Exchange.
  2. Cambridge Approach and Keynesian Liquidity Preference Theory.
  3. Speculative Demand for Money and Transactions Demand for Money.
  4. Endogenous Money Theory and Horizontalist Theory.

Answer: 4. Endogenous Money Theory and Horizontalist Theory.

Explanation:

Post-Keynesian developments in the theory of demand for money focus on two key concepts: Endogenous Money Theory, which emphasizes that money supply is determined endogenously by the central bank and commercial banks based on demand for credit, and Horizontalist Theory, which suggests that banks are not reserve constrained and can create money by lending.

Question 2. How does the Post-Keynesian approach differ from the Keynesian Theory of Demand for Money?

  1. The post-Keynesian approach focuses on the speculative motive, while Keynesian Theory emphasizes the transactions motive.
  2. The post-Keynesian approach emphasizes the speculative motive, while Keynesian Theory focuses on the precautionary motive.
  3. The post-Keynesian approach considers money supply as endogenous, while Keynesian Theory treats it as exogenous.
  4. The post-Keynesian approach considers the money supply as exogenous, while Keynesian Theory treats it as endogenous.

Answer: 3. The Post-Keynesian approach considers money supply as endogenous, while Keynesian Theory treats it as exogenous.

Explanation:

The key difference between the Post-Keynesian approach and the Keynesian Theory of Demand for Money lies in their treatment of money supply. The Post-Keynesian approach views money supply as endogenous, determined by the banking system’s lending behavior, while the Keynesian Theory considers it as exogenous, controlled by the central bank.

Question 3. According to the Post-Keynesian view, how does the demand for money relate to the interest rate?

  1. There is a positive relationship between the demand for money and the interest rate.
  2. There is a negative relationship between the demand for money and the interest rate.
  3. The demand for money is not influenced by changes in the interest rate.
  4. The demand for money is solely determined by changes in the money supply.

Answer: 2. There is a negative relationship between the demand for money and the interest rate.

Explanation:

According to the Post-Keynesian view, there is a negative relationship between the demand for money and the interest rate. As interest rates rise, the opportunity cost of holding money increases, leading to a decrease in the demand for money.

Question 4. How does the Post-Keynesian approach view the role of banks in the money creation process?

  1. Banks play a passive role and cannot influence the money supply.
  2. Banks can actively control the money supply through their lending decisions.
  3. Banks are solely responsible for determining the quantity of money in circulation.
  4. The money supply is determined independently of banks’ actions.

Answer: 2. Banks can actively control the money supply through their lending. decisions. ‘

Explanation:

The Post-Keynesian approach recognizes that banks play an active role in the money creation process. Through their lending decisions, banks can influence the money supply and create new money.

Question 5. According to the Post-Keynesian perspective, what drives the demand * for money in an economy?

  1. Changes in the level of income and interest rates.
  2. Changes in the price level and exchange rates.
  3. Changes in the government’s fiscal policy.
  4. Changes in the money supply by the central bank.

Answer: 1. Changes in the level of income and interest rates.

Explanation:

The Post-Keynesian perspective highlights that the demand for money is primarily driven by changes in the level of income and interest rates. As income rises or interest rates change, individuals and firms adjust their demand for money.

Question 6. Which of the following is a major criticism of the Post-Keynesian view of the demand for money?

  1. It neglects the importance of interest rates in determining the demand for money. .
  2. It overemphasizes the role of banks in the money-creation process.
  3. It fails to consider the impact of fiscal policy on money demand.
  4. It lacks empirical evidence to support its claims.

Answer: 4. It lacks empirical evidence to support its claims.

Explanation:

One major criticism of the Post-Keynesian view of the demand for money is that it has been criticized for lacking sufficient empirical evidence to support its claims and assumptions about the money creation process by banks and the endogenous nature of the money supply.

Question 7. Post-Keynesian economists argue that the demand for money is primarily determined by

  1. The interest rate
  2. The level of income and economic activity
  3. Future expectations of inflation
  4. Government policies

Answer: 2. The level of income and economic activity

Question 8. According to post-Keynesian views, the speculative demand for money is related to people’s desire to

  1. Hold liquid assets for convenience
  2. Invest in stocks and bonds
  3. Avoid holding money due to inflation
  4. Minimize transaction costs

Answer: 3. Avoid holding money due to inflation

Question 9. In the post-Keynesian approach, the precautionary demand for money is driven by the need to have sufficient funds for

  1. Speculative purposes
  2. Everyday transactions
  3. Emergencies and uncertainties
  4. Long-term savings

Answer: 3. Emergencies and uncertainties

Question 10. Post-Keynesian economists argue that the demand for money can be affected by changes in

  1. Government expenditures
  2. The money supply
  3. Interest rates
  4. All of the above

Answer: 4. All of the above

Question 11. The liquidity preference theory, developed by John Maynard Keynes, emphasizes that the demand for money depends on

  1. The nominal interest rate
  2. The real interest rate
  3. Future expectations of inflation
  4. Both (1) and (2)

Answer: 4. Both (1) and (2)

 Inventory Approach To Transaction Balances

Question 1. What does the Inventory Approach to Transaction Balances refer to?

  1. Holding money as a precautionary measure to cover future uncertainties.
  2. Holding money to take advantage of potential changes in the value of financial assets.
  3. Holding money to facilitate day-to-day transactions based on the desired frequency of purchases.
  4. Holding money as an inventory to manage cash flows in a business.

Answer: 4. Holding money as an inventory to manage cash flows in a business.

Explanation:

The Inventory Approach to Transaction Balances is a concept used in the context of business and firms. It refers to holding money as an inventory or buffer to manage cash flows efficiently and cover various transactional needs, such as paying suppliers, meeting operational expenses, and managing working capital.

Question 2. According to the Inventory Approach, how does the size of a firm’s cash balance relate to the desired level of transactions?

  1. The cash balance is unrelated to the desired level of transactions.
  2. The cash balance is always equal to the desired level of transactions.
  3. The cash balance is determined by the desired level of transactions.
  4. The cash balance is inversely related to the desired level of

Answer: 1. The cash balance is determined by the desired level of transactions.

Explanation:

According to the Inventory Approach, the size of a firm’s cash balance is determined by the desired level of transactions or the expected cash outflows and inflows associated with business operations. The firm aims to maintain an appropriate cash balance to meet its transactional needs efficiently.

Question 3. How does the Inventory Approach explain the opportunity cost of holding cash? 

  1. Holding cash incurs no opportunity cost.
  2. The opportunity cost of holding cash is equal to the interest rate.
  3. The opportunity cost of holding cash is equal to the potential returns from investment
  4. The opportunity cost of holding cash is equal to the inflation rate.

Answer: 2. The opportunity cost of holding cash is equal to the potential returns from investment.

Explanation:

The Inventory Approach acknowledges that holding cash incurs an opportunity cost, as the cash could have been invested to earn potential returns. By holding cash, the firm foregoes the opportunity to earn interest or returns that could have been generated through investment.

Question 4. What is the primary focus of the Inventory Approach in managing transaction balances?

  1. Maximizing cash holdings to ensure liquidity at all times. ‘
  2. Minimizing cash holdings to reduce the opportunity cost.
  3. Optimizing cash holdings to strike a balance between liquidity and opportunity cost.
  4. Ignoring cash balances and relying on credit for transactions.

Answer: 3. Optimizing cash holdings to strike a balance between liquidity and opportunity cost.

Explanation:

The primary focus of the Inventory Approach is to optimize cash holdings to strike a balance between the firm’s need for liquidity (to meet transactional requirements) and the opportunity cost of holding cash (foregoing potential investment returns).

Question 5. How does the Inventory Approach view the holding of marketable securities as part of transaction balances?

  1. Marketable securities are considered part of the firm’s cash balance.
  2. Marketable securities are seen as a separate investment category unrelated to transaction balances.
  3. Marketable securities are considered part of the firm’s inventory of goods for sale.
  4. Marketable securities are viewed as a liability for the firm.

Answer: 1. Marketable securities are considered part of the firm’s cash balance.

Explanation: 

The Inventory Approach treats marketable securities (e.g., short-term investments) as part of the firm’s cash balance. These securities are considered as good as cash because they can be readily converted into cash when needed to meet transactional requirements.

Question 6. Which of the following factors would influence a firm’s desired level of transaction balances according to the Inventory Approach?

  1. The firm’s long-term investment plans.
  2. The firm’s dividend payout ratio.
  3. The firm’s credit rating.
  4. The firm’s average transaction size and frequency.

Answer: 4. The firm’s average transaction size and frequency.

Explanation:

According to the Inventory Approach, the desired level of transaction balances is influenced by the firm’s average transaction size and frequency. Larger transaction sizes and higher transaction frequencies would require the firm to hold a larger cash balance.

Question 7. The inventory approach to transaction balances suggests that the demand for money is influenced by

  1. The interest rate
  2. The level of income and economic activity,
  3. The cost of holding money and the cost of converting other assets, into money
  4. Future expectations of inflation

Answer: 3. Future expectations of inflation

Question 8. According to the inventory approach, individuals and firms hold money to

  1. Speculate on future interest rates
  2. Facilitate transactions for goods and services
  3. Invest in financial markets
  4. Avoid taxes

Answer: 2. Facilitate transactions for goods and services

Question 9. The inventory approach to transaction balances suggests that an- increase in the cost of converting assets into money will lead to

  1. An increase in the demand for money
  2. A decrease in the demand for money
  3. No change in the demand for money
  4. An increase in the velocity of money

Answer: 1. An increase in the demand for money

Question 10. In the inventory approach, the decision to hold money is based on a trade-off between the benefits of liquidity and the

  1. Risk of inflation
  2. The opportunity cost of holding money
  3. Government interventions in the economy
  4. Exchange rate fluctuations

Answer: 2. The opportunity cost of holding money

Question 11. The inventory approach to transaction balances is often used to explain

  1. The demand for money in developing economies
  2. The demand for money in advanced economies
  3. The impact of government policies on money demand
  4. The relationship between money supply and interest rates

Answer: 2. The demand for money in advanced economies

Friedman’s Restatement Of The Quantity Theory

Question 1. What is the key proposition of Friedman’s Restatement of the Quantity Theory of Money?

  1. Money supply has a significant impact on aggregate demand and economic output.
  2. Inflation is primarily determined by changes in the money supply.
  3. The velocity of money is constant in the long run.
  4. Fiscal policy is more effective than monetary policy in stabilizing the economy.

Answer: 2. Inflation is primarily determined by changes in the money supply.

Explanation:

Friedman’s Restatement of the Quantity Theory of Money emphasizes that inflation is primarily caused by changes in the money supply in the long run. According to this view, an increase in the money supply leads to a proportional increase in the price level.

Question 2. According to Friedman, what role does the velocity of money play in the Quantity Theory of Money?

  1. The velocity of money is constant and has no impact on inflation.
  2. The velocity of money is volatile and leads to frequent changes in inflation.
  3. The velocity of money is a key determinant of inflation.
  4. The velocity of money is irrelevant in explaining inflation.

Answer: 1. Velocity of money is a key determinant of inflation.

Explanation:

In Friedman’s Restatement, the velocity of money is viewed as a key determinant of inflation. It represents the rate at which money changes hands during a given period, and changes in velocity can amplify or dampen the effects of changes in the money supply on inflation.

Question 3. According to Friedman, what is the primary cause of business cycles?

  1. Fluctuations in government spending.
  2. Changes in aggregate demand due to money supply changes.
  3. Shocks in the financial markets.
  4. Technological advancements.

Answer: 2. Changes in aggregate demand due to money supply changes.

Explanation:

Friedman argues that changes in the money supply, and subsequently changes in aggregate demand, are the primary cause of business cycles. An increase in the money supply leads to an increase in aggregate demand, resulting in an expansionary phase of the business cycle, and vice versa.

Question 4. How does Friedman view the role of monetary policy in controlling inflation?

  1. Monetary policy is ineffective in controlling inflation.
  2. Monetary policy is the primary tool to control inflation.
  3. Fiscal policy is more effective than monetary policy in controlling inflation.
  4. Controlling inflation is beyond the scope of monetary policy.

Answer: 1. Monetary policy is ineffective in controlling inflation.

Explanation:

Friedman believes that monetary policy is generally ineffective in controlling inflation in the long run. According to him, changes in the money supply only have temporary effects on real variables such as output and employment, but they do not have a long-lasting impact on inflation.

Question 5. What is the main criticism of Friedman’s Restatement of the Quantity Theory of Money?

  1. It ignores the impact of fiscal policy on the economy.
  2. It assumes that the velocity of money is constant, which is not always the case.
  3. It does not consider the role of financial markets in influencing inflation.
  4. It underestimates the importance of changes in the money supply on inflation.

Answer: 2. It assumes that the velocity of money is constant, which is not always the case.

Explanation:

One of the main criticisms of Friedman’s Restatement is its assumption of constant velocity of money. In reality, the velocity of money can fluctuate, making it challenging to
accurately predict the relationship between money supply and inflation.

Question 6. How does Friedman’s Restatement view the long-run effects of changes in the money supply?

  1. Changes in the money supply have long-lasting effects on inflation and output
  2. Changes in the money supply have short-term effects on inflation and output
  3. Changes in the money supply have no impact on inflation and output in the long run.
  4. Changes in the money supply have no impact on inflation but affect output in the long run.

Answer: 4. Changes in the money supply have no impact on inflation and output in the long run.

Explanation:

According to Friedman, changes in the money supply have no significant impact on inflation and output in the long run. Instead, they only affect nominal variables, while real variables are determined by non-monetary factors.

Question 7. Milton Friedman’s restatement of the quantity theory of money emphasized that the demand for money depends on

  1. The level of income and economic activity
  2. The interest rate
  3. Future expectations of inflation.
  4. Both (1) and (2)

Answer: 4. Both (1) and (2)

Question 8. According to Friedman, changes in the quantity of money affect

  1. Interest rates only
  2. Price levels only
  3. Both interest rates and price levels
  4. Exchange rates

Answer: 3. Both interest rates and price levels

Question 9. Friedman’s restatement suggested that in the long run, changes in the quantity of money primarily influence

  1. Real economic variables such as output and employment
  2. Nominal economic variables such as the price level
  3. Government fiscal policies
  4. International trade and capital flows

Answer:  2. Nominal economic variables such as the price level

Question 10. Friedman argued that central banks should focus on

  1. Controlling the money supply to stabilize the economy
  2. Manipulating interest rates to influence investment
  3. Implementing exchange rate policies to boost exports
  4. Directly managing government expenditures and taxation

Answer: 1. Controlling the money supply to stabilize the economy

Question 11. According to Friedman, excessive inflation is primarily caused by

  1. An increase in government spending
  2. Excessive growth in the money supply
  3. Fluctuations in exchange rates
  4. A decrease in interest rates

Answer: 2. Excessive growth in the money supply

The Demand For Money As Behaviour Toward Risk

Question 1. What does the “Demand for Money as Behavior toward Risk” refer to

  1. Holding money as a precautionary measure to cover future uncertainties.
  2. Holding money to take advantage of potential changes in the value of financial assets.
  3. Holding money based on risk aversion and the desire to avoid holding risky assets.
  4. Holding money as an inventory to manage cash flows in a business.

Answer: 2. Holding money based on risk aversion and the desire to avoid holding risky assets.

Explanation:

The “Demand for Money as Behavior toward Risk” refers to the preference of individuals to hold money as a safe and low-risk asset, driven by risk aversion and the desire to avoid holding riskier assets, such as stocks or bonds.

Question 2. According to the Demand for Money as Behavior toward Risk, what happens to the demand for money when individuals become more risk-averse?

  1. The demand for money increases.
  2. The demand for money decreases.
  3. The demand for money remains unchanged.
  4. The. demand for money is solely determined by changes in the money supply.

Answer: 1. The demand for money increases.

Explanation:

According to the Demand for Money as Behavior toward Risk, when individuals become more risk-averse, they tend to hold more money as a safe and less risky asset. As a result, the demand for money increases.

Question 3. How does the Demand for Money as Behavior toward Risk explain the preference for holding money in liquid form?

  1. People prefer to hold money as it generates interest income.
  2. People prefer to hold money to preserve wealth.
  3. People prefer to hold money for speculative purposes.
  4. People prefer to hold money to avoid the risk of illiquidity.

Answer: 4. People prefer to hold money to avoid the risk of illiquidity.

Explanation:

The Demand for Money as Behavior toward Risk explains that people prefer to hold money in liquid form to avoid the risk of illiquidity. Liquid money can be easily accessed and used to meet financial needs without the need to sell risky or illiquid assets.

Question 4. Which of the following situations would lead to an increase in the demand for money due to the Demand for Money as Behavior toward Risk?

  1. An increase in economic stability.
  2. A decrease in the availability of credit facilities.
  3. A decrease in disposable income.
  4. A decrease in the perceived level of financial risk.

Answer: 4. A decrease in the perceived level of financial risk.

Explanation:

A decrease in the perceived level of financial risk would make individuals less risk-averse and less inclined to hold money as a safe asset. Therefore, it would lead to a decrease in the demand for money due to the Demand for Money as Behavior toward Risk.

Question 5. How does the Demand for Money as Behavior toward Risk influence the allocation of wealth between money and other financial assets?

  1. It encourages a higher allocation of wealth to money.
  2. It encourages a lower allocation of wealth to money.
  3. It has no impact on the allocation of wealth.
  4. It leads to unpredictable changes in wealth allocation.

Answer: 1. It encourages a higher allocation of wealth to money.

The Demand for Money as Behavior toward Risk encourages individuals to hold a higher proportion of their wealth in the form of money as a safe and low-risk asset to manage the uncertainty associated with riskier financial assets. ‘

Question 6. According to the Demand for Money as Behavior toward Risk, how does the level of economic uncertainty affect the demand for money?

  1. An increase in economic uncertainty leads to an increase in the demand for money.
  2. An increase in economic uncertainty leads to a decrease in the demand for money.
  3. The level of economic uncertainty has no impact on the demand for money.
  4. The demand for money is solely determined by changes in the money supply.

Answer: 1. An increase in economic uncertainty leads to an increase in the demand for money.

Explanation:

According to the Demand for Money as Behavior toward Risk, an increase in economic uncertainty leads to an increase in the demand for money as individuals become more risk-averse and prefer to hold safe assets in uncertain times.

Question 7. The demand for money as behavior toward risk suggests that individuals may hold more money when they

  1. Have higher income levels
  2. Expect future inflation.
  3. Perceive higher uncertainty or risk in the economy
  4. Expect interest rates to decrease

Answer: 3. Perceive higher uncertainty or risk in the economy

Question 8. In the context of the demand for money as behavior toward risk, holding money provides individuals with a sense of

  1. Liquidity and flexibility
  2. Long-term investment opportunities
  3. Tax advantages
  4. Higher returns compared to other assets

Answer: 1. Liquidity and flexibility

Question 9. According to the demand for money as behavior toward risk, during times of economic instability or crisis, people tend to

  1. Increase their spending
  2. Invest more in the stock market
  3. Hold more money as a safe asset
  4. Borrow heavily from banks

Answer: 3. Hold more money as a safe asset

Question 10. The demand for money as behavior toward risk is closely related to the concept of

  1. Risk aversion
  2. Speculative motives
  3. Precautionary motives
  4. Money multipliers

Answer: 1. Risk aversion

Question 11. As a risk-averse individual expects higher uncertainty in the future, the demand for money

  1. Increases
  2. Decreases
  3. Remains constant
  4. Becomes dependent on government policies

Answer: 1. Increases

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