Which of the following statistics is correct regarding the liquidity trap
i. It is the point where speculative demand for money is infinitely inelastic and the liquidity preference curve becomes perfectly elastic
ii. It is the point where speculative demand for money is infinitely elastic and the liquidity preference curve becomes perfectly inelastic
iii. It is the point where speculative demand for money is infinitely elastic and the liquidity preference curve becomes perfectly elastic
iv. It is the point where speculative demand for money and the liquidity preference curves are not related.
Show answer & explanation
Correct answer: B
Explanation
The correct answer is Option 2 i.e. Only Statement iii is correct.
The correct statistic regarding the liquidity trap is:
iii. It is the point where speculative demand for money is infinitely elastic and the liquidity preference curve becomes perfectly elastic.
In a liquidity trap, people prefer to hold onto money rather than investing or spending it, regardless of the interest rates. This causes the demand for money to become infinitely elastic because people will hold onto money indefinitely, making the liquidity preference curve perfectly horizontal. In this situation, monetary policy becomes ineffective in stimulating economic activity.