Money supply in the economy increases and people purchase bonds with the extra money. Which of the following chains of effects is correct?
Answer & explanation
Correct answer: option 4
The correct answer is Option (4) → Demand for bonds rises → bond prices rise → rate of interest falls
Extra money spent on bonds raises the demand for bonds, so their prices rise. Bond prices and the rate of interest move in opposite directions, so the rate of interest falls.
Option (1) Demand for bonds falls → bond prices rise → rate of interest falls — Incorrect. Buying bonds raises their demand.
Option (2) Demand for bonds rises → bond prices rise → rate of interest rises — Incorrect. A higher bond price means a lower rate of interest.
Option (3) Demand for bonds rises → bond prices fall → rate of interest rises — Incorrect. Higher demand raises bond prices.
Option (4) Demand for bonds rises → bond prices rise → rate of interest falls — Correct. Each step follows from the one before.
NCERT (2026-27): “The Speculative Motive … It follows that the price of a bond is inversely related to the market rate of interest. …” “… As mentioned earlier, interest rate can be thought of as an opportunity cost or ‘price’ of holding money balance. If supply of money in the economy increases and people purchase bonds with this extra money, demand for bonds will go up, bond prices will rise and rate of interest will decline. …” |