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Q60 (IAS/2013) Economy › Money, Banking & Inflation › Interest rate concepts Answer Verified

Supply of money remaining the same when there is an increase in demand for money, there will be

Result
Your answer: —  Â·  Correct: B
Explanation

According to the liquidity preference theory, the interest rate is determined by the intersection of money supply and money demand. Money is held for transaction and speculative motives, and the interest rate represents the opportunity cost of holding this liquid cash. When the supply of money is fixed by the central authority and remains unchanged, any increase in the demand for money (shifting the demand curve to the right) creates a shortage of money at the existing interest rate. To restore equilibrium, the interest rate must rise. This occurs because as people demand more money, they sell interest-bearing assets like bonds to gain liquidity; the resulting fall in bond prices leads to an increase in the market rate of interest. Conversely, a decrease in money demand with a constant supply would lead to a fall in interest rates.

Sources

  1. [1] Macroeconomics (NCERT class XII 2025 ed.) > Chapter 3: Money and Banking > Box 3.1: Demand and Supply for Money : A Detailed Discussion > p. 43
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