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Keynes' concept of 'Liquidity Preference' is based on three reasons why people desire to hold wealth in money form - Leaving Cert Economics - Question b - 2009
Question b
Keynes' concept of 'Liquidity Preference' is based on three reasons why people desire to hold wealth in money form. (i) State and explain each of these reasons. (i... show full transcript
Worked Solution & Example Answer:Keynes' concept of 'Liquidity Preference' is based on three reasons why people desire to hold wealth in money form - Leaving Cert Economics - Question b - 2009
Step 1
State and explain each of these reasons.
Answer
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Transactionary Motive: People desire to hold money for day-to-day expenses such as buying goods and services. This motive emphasizes the need for liquidity to facilitate everyday transactions without delays.
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Precautionary Motive: This motive reflects the desire to hold money for unexpected emergencies or unforeseen events, such as illness or home repairs. Individuals retain cash to ensure they can address sudden financial needs without reliance on borrowing, which can be costly.
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Speculative Motive: Individuals may want to hold money for potential profitable investment opportunities. This approach indicates that people may prefer to keep cash in hand to take advantage of favorable market conditions, rather than committing to investments that may not be immediately liquid.
Step 2
Discuss the effect, if any, a fall in interest rates is generally expected to have on each of these reasons.
Answer
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Transactionary Motive: The demand for money for transactionary reasons is not affected by the fall in the rate of interest. This is because people require cash for day-to-day expenses, which are dictated more by their income level rather than the rates of interest.
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Precautionary Motive: The precautionary motive is slightly negatively affected by a fall in interest rates. As interest rates decline, individuals may hold slightly more money for precautionary purposes as the opportunity cost of holding cash decreases, causing people to feel more secure about having liquid assets available.
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Speculative Motive: The speculative motive is greatly affected negatively by the fall in interest rates. Lower interest rates can lead to a scenario where individuals hold more money for speculative investment, as they may foresee potential profits from future higher rates and want to maintain cash on hand to capitalize on these opportunities.