The correct answer is Option (2) → Liquidity trap
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A liquidity trap occurs when the market rate of interest is very low, and people expect it to rise in the future.
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As a result, they anticipate capital losses on bonds (since bond prices will fall when interest rates rise).
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Therefore, people prefer to hold cash instead of bonds — causing the speculative demand for money to become infinite.
- In a liquidity trap, conventional monetary policy (like lowering interest rates) becomes ineffective because people hoard money and do not invest or spend it, regardless of how much money is pumped into the economy.
Other Options:
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Jevons Paradox: Refers to the counter-intuitive situation where technological progress increases the efficiency with which a resource is used, but the rate of consumption of that resource rises due to increasing demand.
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Paradox of Thrift: Describes how an increase in autonomous saving by individuals or households can lead to a decrease in aggregate demand and, consequently, a fall in total savings in the economy.
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Double coincidence of wants: A condition required for a barter exchange to occur, where each party must want what the other party has.
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