Assume the money market is initially in equilibrium. If the price level decreases, according to liquidity-preference theory, what is in excess and for how long?
A) The supply of money is in excess until the interest rate increases.
B) The supply of money is in excess until the interest rate decreases.
C) The demand for money is in excess until the interest rate increases.
D) The demand for money is in excess until the interest rate decreases.

Question

Quizplus · Accepted Answer

When the price level decreases, the real value of money balances increases, leading to an excess supply of money. According to liquidity-preference theory, this situation persists until the interest rate decreases, which encourages more borrowing and spending, thereby restoring equilibrium in the money market.

Assume the Money Market Is Initially in Equilibrium