In this portion of the curve, the demand for money is infinitely elastic with respect to the interest rate. 6 as a result of anticipated changes in bond prices. A shift of the money- supply curve from Ms 0 to Ms 1 by the central bank. Expert Answer view the full answer Transaction Motive 2. The horizontal portion of the liquidity preference curve is referred to as the liquidity trap. Reductions in the interest rate, in this portion only, increases peopleâs desire to hold cash balances. The liquidity-preference relation can be represented graphically as a schedule of the money demanded at each different interest rate. The demand curve slopes downward because when the interest rate is high, most people invest more and hold less cash. In part (a) of the figure, LPS is the cur of liquidity preference for speculative motive. Under Keynes's Chapter 13 liquidity preference doctrine the LM curve will be a horizontal line. This perfectly elastic portion of liquidity preference curve indicates the position of absolute liquidity preference â¦ In other words, LPS curve shows the demand for money for speculative motive. For the LM curve, when we think about liquidity preference, holding real money constant, high levels of GDP, a lot of economic activity, people want to have currency, demand for currency is high so the price is currency is high which is real interest rates and so we would have real interest rates high due to liquidity preference. How the rate of interest is determined by the equilibrium between the liquidity preference for speculative motive and the supply of money is shown in Fig. 34.4. Speculative Motive It will be seen from Fig. 18.2 that the liquidity preference curve LP becomes quite flat i.e., perfectly elastic at a very low rate of interest; it is horizontal line beyond point Eâ towards the right. The demand curve slopes downward because higher interest rates reduce the quantity of real money balances demanded. c. money demand curve left so the interest rate decreases. 2. The IS curve always slopes downwards. That is, the interest rate adjusts to equilibrate the money market. According to liquidity preference theory, an increase in the price level shifts the Question 9 options: a. money demand curve right so the interest rate increases. d. money demand curve left so the interest rate increases. 1. According to the theory of liquidity preference, the supply and demand for real money balances determine what interest rate prevails in the economy. b. money demand curve right so the interest rate decreases. In the money market money supply is a fixed amount determined by the central bank whereas money demand is a downward-sloping function (interest rate) as a function of (income) and (quantity of money). A liquidity preference curve is a demand curve for money because a householdâs or businessâs value of liquidity is the same as its demand for cash. According to Keynes people demand liquidity or prefer liquidity because they have three different motives for holding cash rather than bonds etc. This Demonstration illustrates how the liquidity preferenceâmoney supply (or LM) curve is formed; the curve shows equilibrium points in the money market. A shift of the liquidity preference curve from Md 0 to Md 1 as shown in Fig. According to the liquidity preference theory, a flat yield curve would be interpreted as the market expecting ____ in interest rates. Precaution Motive 3. LIQUIDITY PREFERENCE THEORY The cash money is called liquidity and the liking of the people for cash money is called liquidity preference. Under his Chapter 15 doctrine, if L is an increasing function of Y and a decreasing function of r, then the LM curve will slope upwards. The supply of money together with the liquidity-preference curve in theory interact to determine the interest rate at which the quantity of money demanded equals the quantity of money supplied (see IS/LM model).