Question

A surplus or shortage in the money market is eliminated by adjustments in the price level according to a. classical theory, but not liquidity preference theory. b. neither liquidity preference theory nor classical theory. c. liquidity preference theory, but not classical theory. d. both liquidity preference theory and classical theory.

Answer 1

Answer:

The correct answer is option a.

Explanation:

According to the classical economists, in the money market the equilibrium is achieved by the intersection of demand for money and supply of money curves. The supply of money is constant. They believed that money was demanded to make transactions. The amount of money needed then would depend on the value of transactions. They believed that there is a direct relationship between money supply and price level.

The liquidity preference theory however stated that money is used for transactionary, precautionary and speculative motives. And the money supply is not directly related with the price level. Interest rate also effects the demand and supply of money.