Real GDP rises and, at the same time, the market rate of interest rises. Going by the two motives for holding money, what happens to the transaction demand and the speculative demand for money?
Answer & explanation
Correct answer: option 2
The correct answer is Option (2) → The transaction demand rises, and the speculative demand falls.
People hold money for transactions, and this demand moves with real GDP. A higher GDP means more buying and selling, so the transaction demand rises.
People also hold money as an asset in place of bonds. This speculative demand moves opposite to the rate of interest: a higher rate makes bonds more attractive, so the speculative demand falls.
NCERT (2026-27): “The Speculative Motive … When r = rmax, speculative demand for money is zero. The rate of interest is so high that everyone expects it to fall in future and hence is sure about a future capital gain. Thus everyone has converted the speculative money balance into bonds. When r = rmin, the economy is in the liquidity trap. Everyone is sure of a future rise in interest rate and a fall in bond prices. Everyone puts whatever wealth they acquire in the form of money and the speculative demand for money is infinite. Total demand for money in an economy is, therefore, composed of transaction demand and speculative demand. The former is directly proportional to real GDP and price level, whereas the latter is inversely related to the market rate of interest. …” |