Keynes's liquidity preference theory indicates that the demand for money is ________ related to ________.

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Question restatement: Keynes's liquidity preference theory indicates that the demand for money is ________ related to ________.

Option A (hypothetical): Positively related to interest rates. This would imply that as interest rates rise, people demand more money, which contradicts liquidity preference theory. The theory emphasizes the opportunity cost of holding money: higher interest rates make holding money less attractive, reducing money demand.

Option B (hypothetical): Unrelated to interest rates. If money demand were unrelated to interest rates, changes in interest rates would not influence how much money people want to hold, which contradicts the core idea of liquidity preference—money is held for liquidity purposes, but its desirability declines when returns on other assets rise.

Option C (stated in provided answer): Negatively related to interest rates. This aligns with Keynesian thinking: when interest rates are high, the opportunity cost of holding money increases, so people hold less money and demand for money falls; when rates are low, money demand tends to rise.

Option D (hypothetical): Related to income only, not to interest rates. This would miss the central relationship described by liquidity preference, which explicitly ties money demand to the price of money relative to other assets, i.e., the interest rate, rather than solely to income.

Key concept elaboration: Liquidity preference explains why the demand for money is inversely related to the return on other assets. At higher interest rates, bonds and other securities yield more, so households substitute away from money toward interest-earning assets, decreasing money demand. Conversely, lower interest rates reduce the incentive to hold alternative assets, increasing money demand.

In summary, the correct interpretation is that the demand for money is negatively related to interest rates, which is consistent with the standard Keynesian liquidity preference framework. The other proposed relationships conflict with the core mechanism of opportunity cost and asset substitution that drives money demand.

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Keynes's liquidity preference theory indicates that the demand for money is related to .

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