The money demand curve is downward sloping because lower interest rates: a. lower the opportunity cost of holding money and cause households and firms to switch from financial assets to money. b. raise the opportunity cost of holding money and cause households and firms to switch from money to bonds. c. lower the opportunity cost of holding money and cause households and firms to switch from money to financial assets. d. raise the opportunity cost of holding money and cause households and firms to switch from money to shares.
Question
The money demand curve is downward sloping because lower interest rates:
a. lower the opportunity cost of holding money and cause households and firms to switch from financial assets to money.
b. raise the opportunity cost of holding money and cause households and firms to switch from money to bonds.
c. lower the opportunity cost of holding money and cause households and firms to switch from money to financial assets.
d. raise the opportunity cost of holding money and cause households and firms to switch from money to shares.
Solution
The correct answer is:
a. lower the opportunity cost of holding money and cause households and firms to switch from financial assets to money.
This is because when interest rates are lower, the opportunity cost of holding money (i.e., the potential interest income foregone by not investing the money) is also lower. This makes holding money more attractive compared to holding financial assets like bonds or stocks, which may offer lower returns when interest rates are low. Therefore, households and firms are more likely to hold money rather than financial assets, leading to an increase in money demand. This is why the money demand curve is downward sloping: as interest rates decrease, the demand for money increases.
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