According to the theory of liquidity preference, holding the supply of real money balances constant, an increase in income will ______ the demand for real money balances and will ______ the interest rate.
A) increase; increase
B) increase; decrease
C) decrease; decrease
D) decrease; increase

Question

Quizplus · Accepted Answer

According to the theory of liquidity preference, an increase in income increases the demand for real money balances because people want to hold more money for transactions. With the supply of real money balances constant, this increased demand leads to an increase in the interest rate as people are willing to pay more to hold money.

According to the Theory of Liquidity Preference, Holding the Supply