Answer to Question #227715 in Macroeconomics for don

Question

(a) According to John Keynes liquidity preference depends on three motives. Explain.  [15 marks]

Answer 1

Liquidity preference theory states that the demand for money is not to borrow money but it's a desire to remain liquid. 

The three motives include ;

(1)Transactions motive - in this motive, it relates to the demand for money to enable the current transactions of an individual and business exchanges. Individuals prefer holding cash in order to cover the gap between the receipts of income as well as it's expenditures.

(2) Precautionary motive - this motive refers to the desire to hold cash balances for unexpected situations. Individuals hold some cans for them to be able to provide for illness, accidents and other unexpected situations whenever they arise.

(3) Speculative motive - it relates to the desire to hold one's funds in liquid form in order to benefit in the future in case of changes in the rate of interest of bond prices. According to the Keynes,the higher the rate of interest the lower the speculative demand for money and the lower the rate of interest the higher the higher the speculative demand for money.