In a liquidity trap, the speculative money demand function is:
Answer & explanation
Correct answer: option 4
The correct answer is Option (4) → infinitely elastic
In a liquidity trap the rate of interest is at its floor. Everyone expects it to rise, so people hold any extra money as money. Speculative demand for money becomes infinite at that rate, so the demand function is infinitely elastic.
NCERT (2026-27): “The Speculative Motive … However, if the market rate of interest is already low enough so that everybody expects it to rise in future, causing capital losses, nobody will wish to hold bonds. Everyone in the economy will hold their wealth in money balance and if additional money is injected within the economy it will be used up to satiate people’s craving for money balances without increasing the demand for bonds and without further lowering the rate of interest below the floor rmin. Such a situation is called a liquidity trap. The speculative money demand function is infinitely elastic here. …” |