CUET UG Economics Booster Test 2

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CUET UG Economics Booster Test 2 - Demand for Money

⏱️ 30 Minutes

❓ 20 Questions

📌 Answers are locked once submitted — results and explanations appear at the end.

CUET UG Economics Booster Test 2 - Demand for Money

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QUESTION 1 OF 20

The demand for money tells us what makes people desire a certain amount of money. Since money is required to conduct transactions, the ____________ of transactions will determine the money people will want to keep.

Answer Review

1 The demand for money tells us what makes people desire a certain amount of money. Since money is required to conduct transactions, the ____________ of transactions will determine the money people will want to keep.

A opportunity cost

B liquidity trap

C value

D velocity

💡 Short Explanation

�� Money is demanded mainly for transactions. �� The value of transactions determines money holdings. �� Higher transaction value requires higher money balances.

✅ Correct Answer Explanation

According to the NCERT, transaction demand for money depends upon the value of transactions that individuals undertake. As the value of goods and services purchased increases, people need to hold more money to complete these transactions. Therefore, the blank should be filled with "value". Hence, Option C is correct. Option A is incorrect because opportunity cost affects speculative demand rather than filling the statement. Option B is unrelated to transaction demand. Option D refers to the frequency with which money changes hands, not the determinant described in the statement.

❓ Why Other Options Are Incorrect

�� Option A → Opportunity cost influences the decision to hold money but does not determine the value of transactions.
�� Option B → Liquidity trap is an extreme low-interest-rate situation and is unrelated here.
�� Option D → Velocity measures how often money circulates, not the transaction value itself.

🎯 Strategy

Used

Contextual/Tonal Matching

Application:

Identify the missing word that logically completes the NCERT explanation of transaction demand.

Final Logic:

Money required depends on the value of transactions, making Option C correct.

🧠 Memory Trick

More Value → More Money Needed

📚 Class XII – Introductory Macroeconomics – Chapter: Money and Banking – Topic: Demand for Money and Transaction Motive

2 Which combination of factors correctly outlines the determinants of total money demand in an economy?

A Quantum of transactions, general price level, and market rate of interest.

B Currency deposited in foreign banks and barter exchange rates.

C Statutory Liquidity Ratio (SLR) and Cash Reserve Ratio (CRR).

D The central bank's repo rate and the printing capacity of mints.

💡 Short Explanation

�� Transaction demand depends on income and price level. �� Speculative demand depends on interest rate. �� Together they determine total money demand.

✅ Correct Answer Explanation

Total demand for money consists of: Transaction Demand (MdT), which depends on the quantum/value of transactions, real GDP, and the general price level. Speculative Demand (MdS), which depends on the market rate of interest. Thus, the determinants of total money demand are: Quantum of transactions General price level Market rate of interest Therefore, Option A is correct. Option B refers to foreign banking and barter, which are unrelated. Option C lists monetary policy ratios that affect money supply rather than money demand. Option D mentions policy instruments but not the fundamental determinants of money demand.

❓ Why Other Options Are Incorrect

�� Option B → Foreign deposits and barter exchange rates are not determinants of money demand.
�� Option C → SLR and CRR influence money supply, not the public's demand for money.
�� Option D → Repo rate influences interest rates indirectly, while printing capacity affects supply rather than demand.

🎯 Strategy

Used

Option Grouping

Application:

Group the determinants of transaction demand and speculative demand together.

Final Logic:

Only Option A combines all major determinants of total money demand.

🧠 Memory Trick

Money Demand = Transactions + Prices + Interest

📚 Class XII – Introductory Macroeconomics – Chapter: Money and Banking – Topic: Determinants of Demand for Money

3 Match the Following related to the two-person economy example in the text:

List 1	List 2
1. Worker's salary	a. Rs 50
2. Total volume of monthly transactions	b. Rs 100
3. Worker's average cash holding	c. Rs 100 (firm + worker)
4. Total transaction demand for money	d. Rs 200

A 1-b, 2-c, 3-a, 4-d

B 1-a, 2-b, 3-c, 4-d

C 1-d, 2-a, 3-b, 4-c

D 1-b, 2-d, 3-a, 4-c

💡 Short Explanation

�� Worker earns Rs 100 salary. �� Monthly transactions total Rs 200. �� Average cash holding equals Rs 50.

✅ Correct Answer Explanation

From the NCERT two-person economy example: Worker's salary = Rs 100 → b Total monthly transactions = Rs 200 → d Worker's average cash holding = Rs 50 → a Total transaction demand for money = Rs 100 (firm + worker) → c Thus, the correct matching is: 1 → b 2 → d 3 → a 4 → c Hence, Option D is correct. The other options incorrectly interchange the salary, transaction value, and average money holdings.

❓ Why Other Options Are Incorrect

�� Option A → Incorrectly matches total monthly transactions with Rs 100.
�� Option B → Incorrectly assigns the worker's salary as Rs 50.
�� Option C → Incorrectly matches almost all quantities.

🎯 Strategy

Used

Option Grouping

Application:

Recall the numerical values from the NCERT two-person economy example and match each correctly.

Final Logic:

Only Option D matches all four values accurately.

🧠 Memory Trick

100 Salary → 200 Transactions → 50 Average Cash

📚 Class XII – Introductory Macroeconomics – Chapter: Money and Banking – Topic: Transaction Demand Example

4 Arrange the logic of transaction needs over a month in order:
1. At the beginning of the month, cash balance is Rs 100.
2. The balance is run down evenly over the rest of the month.
3. Income of Rs 100 is earned on the first day of the month.
4. At the end of the month, cash balance is Rs 0.

A 1, 2, 3, 4

B 3, 1, 2, 4

C 3, 2, 1, 4

D 2, 3, 4, 1

💡 Short Explanation

�� Income is received first. �� The cash balance is initially Rs 100. �� It is gradually spent until it becomes zero.

✅ Correct Answer Explanation

The NCERT illustrates transaction demand using a worker who receives a salary at the beginning of the month and spends it gradually throughout the month. The logical sequence is: Step 3: The worker receives Rs 100 as income on the first day of the month. Step 1: Therefore, the cash balance becomes Rs 100. Step 2: The balance is spent evenly throughout the month. Step 4: By the end of the month, the cash balance falls to Rs 0. Thus, the correct order is: 3 → 1 → 2 → 4 Hence, Option B is correct. Options A, C and D either begin after income has already been received or reverse the natural sequence of transactions.

❓ Why Other Options Are Incorrect

�� Option A → Starts with the cash balance before explaining how it was obtained.
�� Option C → Spending cannot begin before the initial cash balance exists.
�� Option D → Begins with expenditure before income is received.

🎯 Strategy

Used

Contextual/Tonal Matching

Application:

Arrange the events according to the chronological flow of income receipt and expenditure during the month.

Final Logic:

Income → Cash Balance → Spending → Zero Balance.

🧠 Memory Trick

Salary → Cash → Spend → Zero

📚 Class XII – Introductory Macroeconomics – Chapter: Money and Banking – Topic: Transactions Motive Example

5 Consider the following statements about income changes and money demand:
I. An increase in nominal GDP implies an increase in the total value of transactions.
II. A rise in nominal GDP will reduce the transaction demand for money.
III. There exists a stable, positive relationship between the value of transactions and nominal GDP.
Which statements are correct?

A I and II

B I and III

C II and III

D Only III

💡 Short Explanation

�� Higher nominal GDP increases transaction value. �� Transaction demand rises with nominal GDP. �� A positive relationship exists between the two.

✅ Correct Answer Explanation

Statement I is correct because higher nominal GDP (PY) represents a greater value of transactions in the economy. Statement II is incorrect because a rise in nominal GDP increases, rather than reduces, the transaction demand for money. Statement III is correct because NCERT assumes a stable positive relationship between the value of transactions and nominal GDP, leading to the equation: MdT = kPY Thus, Statements I and III are correct. Hence, Option B is the correct answer.

❓ Why Other Options Are Incorrect

�� Option A → Includes Statement II, which is incorrect because transaction demand increases with nominal GDP.
�� Option C → Statement II is false.
�� Option D → Ignores Statement I, which is also correct.

🎯 Strategy

Used

Elimination

Application:

Identify the incorrect statement first and eliminate all options containing it.

Final Logic:

Since Statement II is false, only Option B remains.

🧠 Memory Trick

GDP ↑ → Transactions ↑ → Money Demand ↑

📚 Class XII – Introductory Macroeconomics – Chapter: Money and Banking – Topic: Income Effect on Transaction Demand

6 How does an increase in the general price level (GDP deflator) affect the transaction demand for money, assuming real GDP is constant?

A It reduces the demand for money proportionately.

B It has no effect on the demand for money.

C It increases the transaction demand for money.

D It converts transaction demand entirely into speculative demand.

💡 Short Explanation

�� Transaction demand depends on nominal GDP. �� Nominal GDP = P × Y. �� If prices rise while real GDP remains constant, transaction demand increases.

✅ Correct Answer Explanation

According to the NCERT transaction demand equation: MdT = kPY where: P = General price level (GDP deflator) Y = Real GDP k = Fraction of nominal income held as money If real GDP remains constant but the price level increases, nominal GDP (PY) increases. Since transaction demand is directly proportional to nominal GDP, individuals require more money to carry out the same volume of real transactions. Therefore, Option C is correct. Option A is incorrect because demand does not decrease. Option B ignores the direct role of the price level in the equation. Option D incorrectly mixes transaction demand with speculative demand.

❓ Why Other Options Are Incorrect

�� Option A → A higher price level increases, rather than reduces, transaction demand.
�� Option B → The price level directly affects nominal GDP and hence money demand.
�� Option D → Transaction demand does not become speculative demand.

🎯 Strategy

Used

Substitution

Application:

Apply the equation MdT = kPY while keeping Y constant and increasing P.

Final Logic:

P ↑ → PY ↑ → MdT ↑.

🧠 Memory Trick

Price ↑ = Money Needed ↑

📚 Class XII – Introductory Macroeconomics – Chapter: Money and Banking – Topic: Transaction Demand and Nominal GDP

7 Assertion (A): Money has no opportunity cost because it is the most liquid of all assets.
Reason (R): If money is put in a fixed deposit instead of being held as a cash balance, it can earn interest.

A Both false

B A true, R false

C Both true, R explains A

D A false, R true

💡 Short Explanation

�� Money is highly liquid. �� Holding money sacrifices interest income. �� Therefore, money has an opportunity cost.

✅ Correct Answer Explanation

The assertion is false because money does have an opportunity cost. Although money is the most liquid asset, holding cash instead of depositing it in a bank means giving up interest income. The reason is true because money placed in a fixed deposit earns interest. This forgone interest represents the opportunity cost of holding money. Therefore, Option D is correct.

❓ Why Other Options Are Incorrect

�� Option A → Incorrect because the reason is true.
�� Option B → Incorrect because the assertion is false.
�� Option C → Incorrect because the assertion itself is false.

🎯 Strategy

Used

Contextual/Tonal Matching

Application:

Evaluate the assertion and reason independently using the concept of opportunity cost.

Final Logic:

Liquidity does not eliminate the opportunity cost of holding money.

🧠 Memory Trick

Cash Held = Interest Lost

📚 Class XII – Introductory Macroeconomics – Chapter: Money and Banking – Topic: Opportunity Cost of Holding Money

8 Why does the speculative demand for money show an inverse relation with the rate of interest?

A Because at low interest rates, people expect rates to rise causing capital loss on bonds, so they hold money instead.

B Because high interest rates increase the transaction costs of daily purchases.

C Because the central bank forces commercial banks to lend less at high interest rates.

D Because at low interest rates, the velocity of money automatically increases.

💡 Short Explanation

�� Low interest rates reduce bond returns. �� People expect future interest rates to rise. �� They prefer money to avoid capital losses.

✅ Correct Answer Explanation

Speculative demand for money depends on expectations about future interest rates. When interest rates are very low, people expect them to rise in the future. Since bond prices move inversely with interest rates, rising interest rates will reduce bond prices, causing capital losses. To avoid these losses, individuals prefer to hold money rather than bonds. Therefore, Option A is correct. Option B confuses speculative demand with transaction costs. Option C concerns monetary policy, not speculative behavior. Option D incorrectly links velocity to speculative demand.

❓ Why Other Options Are Incorrect

�� Option B → Interest rates do not directly increase transaction costs.
�� Option C → Lending decisions do not explain speculative demand.
�� Option D → Velocity of money is unrelated to the inverse relationship.

🎯 Strategy

Used

Contextual/Tonal Matching

Application:

Recall Keynes' speculative demand theory relating interest rates and bond prices.

Final Logic:

Low Interest → Expected Rise → Bond Price Fall → Hold Money.

🧠 Memory Trick

Low Interest = Hold Cash

📚 Class XII – Introductory Macroeconomics – Chapter: Money and Banking – Topic: Speculative Demand for Money

9 Demand for money balance is often referred to as liquidity preference. People desire to hold money balances broadly from two motives: the transaction motive and the ____________ motive.

A saving

B investment

C speculative

D foreign exchange

💡 Short Explanation

�� Keynes identified two major motives. �� They are transaction and speculative motives. �� Together they explain liquidity preference.

✅ Correct Answer Explanation

According to Keynesian theory and NCERT, the demand for money (liquidity preference) arises mainly from: Transaction motive Speculative motive The speculative motive explains why individuals hold money instead of bonds depending on expectations about future interest rates. Therefore, Option C is correct. Option A is not one of the two major motives discussed in NCERT. Option B refers to asset acquisition rather than money demand. Option D is unrelated.

❓ Why Other Options Are Incorrect

�� Option A → Saving is not classified as a primary motive for money demand in this context.
�� Option B → Investment is not one of Keynes' two motives in the NCERT chapter.
�� Option D → Foreign exchange is unrelated to liquidity preference.

🎯 Strategy

Used

Odd One Out

Application:

Identify the option that correctly completes the pair of Keynesian motives.

Final Logic:

Transaction + Speculative = Total Money Demand.

🧠 Memory Trick

T + S = Money Demand

📚 Class XII – Introductory Macroeconomics – Chapter: Money and Banking – Topic: Liquidity Preference

10 Match the Following regarding the liquidity trade-off:

List 1	List 2
1. Advantage of holding money	a. Foregone interest earnings
2. Disadvantage of holding money	b. People rush to hold bonds
3. High market interest rate	c. People expect capital loss on bonds
4. Low market interest rate	d. High Liquidity for transactions

A 1-b, 2-c, 3-a, 4-d

B 1-d, 2-a, 3-b, 4-c

C 1-a, 2-d, 3-c, 4-b

D 1-c, 2-b, 3-d, 4-a

💡 Short Explanation

�� Holding money provides liquidity. �� Holding money sacrifices interest. �� Interest rates influence bond-holding decisions.

✅ Correct Answer Explanation

The correct matching is: Advantage of holding money → High liquidity for transactions (d). Disadvantage of holding money → Foregone interest earnings (a). High market interest rate → People rush to hold bonds (b) because bonds offer attractive returns. Low market interest rate → People expect capital loss on bonds (c) if rates rise later. Thus, the correct matching is: 1 → d 2 → a 3 → b 4 → c Hence, Option B is correct.

❓ Why Other Options Are Incorrect

�� Option A → Incorrectly matches liquidity with bond holding.
�� Option C → Reverses the advantage and disadvantage of holding money.
�� Option D → Incorrectly associates high interest rates with liquidity.

🎯 Strategy

Used

Option Grouping

Application:

Match each concept with its corresponding NCERT definition before selecting the answer.

Final Logic:

Only Option B correctly matches all four pairs.

🧠 Memory Trick

Liquidity–Money | Interest–Bonds

📚 Class XII – Introductory Macroeconomics – Chapter: Money and Banking – Topic: Liquidity Preference and Speculative Demand

11 In the formula MdT = k.T, what does the variable 'k' represent?

A A positive fraction representing the ratio of money balance to the value of transactions.

B The total value of (nominal) transactions in the economy.

C The maximum possible limit of the market rate of interest.

D The velocity of circulation of money.

💡 Short Explanation

�� k is a positive fraction. �� It shows the proportion of transaction value held as money. �� It is the reciprocal of the velocity of money.

✅ Correct Answer Explanation

In the transaction demand equation: MdT = kT MdT = Transaction demand for money T = Total value of nominal transactions k = Fraction of transaction value that people wish to hold as money Thus, k measures the ratio of average money balances to the total value of transactions. It is also the inverse (reciprocal) of the velocity of circulation of money (v). Therefore, Option A is correct. Option B defines T, not k. Option C has no relation to the formula. Option D is incorrect because velocity = 1/k, not k itself.

❓ Why Other Options Are Incorrect

�� Option B → Represents T, not k.
�� Option C → Market interest limits are unrelated to the transaction demand equation.
�� Option D → Velocity is the reciprocal of k, not k itself.

🎯 Strategy

Used

Dimensional/Unit Analysis

Application:

Identify the meaning of each symbol in the equation before selecting the answer.

Final Logic:

k is the proportion of transactions held as money.

🧠 Memory Trick

k = Keep Cash

📚 Class XII – Introductory Macroeconomics – Chapter: Money and Banking – Topic: Transaction Demand Formula

12 If real GDP (Y) is 500 units, the price level (P) is 2, and the fraction 'k' is 0.5, what is the transaction demand for money based on the equation MdT = kPY?

A 1000

B 250

C 2000

D 500

💡 Short Explanation

�� Use MdT = kPY. �� Substitute the given values. �� Transaction demand equals 500.

✅ Correct Answer Explanation

Using the equation: MdT = kPY Given: k = 0.5 P = 2 Y = 500 Calculation: MdT = 0.5 × 2 × 500 MdT = 500 Therefore, Option D is correct. Option A results from ignoring k. Option B results from incorrect multiplication. Option C doubles the correct answer.

❓ Why Other Options Are Incorrect

�� Option A → Assumes k = 1 instead of 0.5.
�� Option B → Incorrect multiplication.
�� Option C → Double the correct value.

🎯 Strategy

Used

Substitution

Application:

Insert the given numerical values into the formula.

Final Logic:

0.5 × 2 × 500 = 500.

🧠 Memory Trick

k × P × Y = Money Demand

📚 Class XII – Introductory Macroeconomics – Chapter: Money and Banking – Topic: Transaction Demand Equation

13 The number of times a unit of money changes hands during the unit period is called the velocity of circulation of money, represented by 'v'. It is the ____________ of 'k', the ratio of money balance and the value of transactions.

A square root

B derivative

C product

D inverse

💡 Short Explanation

�� Velocity measures money circulation. �� k measures money holding. �� They are reciprocals of each other.

✅ Correct Answer Explanation

The relationship between velocity (v) and k is: v = 1/k or k = 1/v Thus, the velocity of circulation of money is the inverse (reciprocal) of the ratio of money balances to transaction value. Therefore, Option D is correct. Option A is a mathematical operation unrelated to velocity. Option B is a calculus concept. Option C incorrectly states multiplication instead of reciprocity.

❓ Why Other Options Are Incorrect

�� Option A → Velocity is not the square root of k.
�� Option B → Derivative has no relevance here.
�� Option C → Velocity is the reciprocal, not the product.

🎯 Strategy

Used

Dimensional/Unit Analysis

Application:

Recall the mathematical relationship between v and k.

Final Logic:

v = 1/k.

🧠 Memory Trick

Velocity = 1/k

📚 Class XII – Introductory Macroeconomics – Chapter: Money and Banking – Topic: Velocity of Money

14 Why is the transaction demand for money (MdT) considered a stock concept?

A Because it refers to the stock of money people are willing to hold at a particular point of time.

B Because it measures the total value of monetary transactions made over a year.

C Because it constantly changes hands multiple times in a month.

D Because it represents the flow of income from firms to workers.

💡 Short Explanation

�� Stock variables are measured at a point in time. �� Money demand measures cash balances held. �� Therefore, transaction demand is a stock concept.

✅ Correct Answer Explanation

A stock variable is measured at a particular point in time. Transaction demand for money refers to the amount of money individuals wish to hold as cash balances at a given moment. Although transactions occur continuously, the money balance held for those transactions is measured as a stock. Therefore, Option A is correct. Option B describes a flow variable. Option C defines velocity of money. Option D refers to income flow.

❓ Why Other Options Are Incorrect

�� Option B → Total yearly transactions are measured over time and are therefore flow variables.
�� Option C → This describes velocity of circulation, not transaction demand.
�� Option D → Income is a flow variable.

🎯 Strategy

Used

Odd One Out

Application:

Separate stock concepts from flow concepts.

Final Logic:

Money demand measures the stock of money held.

🧠 Memory Trick

Money Held = Stock

📚 Class XII – Introductory Macroeconomics – Chapter: Money and Banking – Topic: Stock and Flow Concepts

15 How do speculators behave when they feel the current rate of interest (e.g., 5%) is too low to be sustainable over time compared to a normal 8%?

A They buy more bonds as they are cheap.

B They lock their money in fixed deposits for longer terms.

C They expect interest rates to rise, bond prices to fall, and thus hold money instead of bonds.

D They borrow money from banks to buy more properties.

💡 Short Explanation

�� Low interest rates are expected to rise. �� Rising interest rates reduce bond prices. �� Speculators hold money to avoid capital losses.

✅ Correct Answer Explanation

According to Keynes' speculative demand theory, when the current market interest rate is very low, people expect it to increase in the future. Since bond prices move inversely with interest rates, a future increase in interest rates will reduce bond prices, causing capital losses. To avoid these losses, speculators prefer to hold money instead of bonds. Therefore, Option C is correct. Option A is incorrect because speculators avoid buying bonds when they expect bond prices to fall. Option B is not the primary speculative response discussed in NCERT. Option D is unrelated.

❓ Why Other Options Are Incorrect

�� Option A → Buying bonds would expose investors to expected capital losses.
�� Option B → Fixed deposits are not the focus of Keynes' speculative motive.
�� Option D → Borrowing for property investment is unrelated to speculative money demand.

🎯 Strategy

Used

Contextual/Tonal Matching

Application:

Apply the inverse relationship between interest rates and bond prices.

Final Logic:

Low Interest → Expect Rise → Bond Price Falls → Hold Money.

🧠 Memory Trick

Low Interest = Hold Cash

📚 Class XII – Introductory Macroeconomics – Chapter: Money and Banking – Topic: Speculative Demand for Money

16 Arrange the chain of events leading to a capital loss for a bond holder:
1. You suffer a loss as the value of your bond depreciates.
2. You anticipate the interest rate to rise from its currently low level.
3. Market interest rate actually rises.
4. The price of the bond falls in the market.

A 2, 4, 3, 1

B 2, 3, 4, 1

C 3, 2, 1, 4

D 4, 3, 1, 2

💡 Short Explanation

�� People expect interest rates to rise. �� Interest rates actually increase. �� Bond prices fall, causing capital loss.

✅ Correct Answer Explanation

The logical sequence is: Step 2: Investors expect the interest rate to rise from its current low level. Step 3: The market interest rate actually rises. Step 4: Since bond prices and interest rates are inversely related, bond prices fall. Step 1: The investor suffers a capital loss because the bond's market value declines. Thus, the correct order is: 2 → 3 → 4 → 1 Hence, Option B is correct. Options A, C, and D either place the fall in bond prices before the rise in interest rates or reverse the logical sequence.

❓ Why Other Options Are Incorrect

�� Option A → Bond prices cannot fall before the market interest rate actually rises.
�� Option C → Expectations should precede the actual rise in interest rates.
�� Option D → Begins with the bond price falling before the cause occurs.

🎯 Strategy

Used

Contextual/Tonal Matching

Application:

Arrange the events according to the inverse relationship between interest rates and bond prices.

Final Logic:

Expectation → Interest Rate Rise → Bond Price Fall → Capital Loss.

🧠 Memory Trick

Interest ↑ → Bond ↓ → Loss

📚 Class XII – Introductory Macroeconomics – Chapter: Money and Banking – Topic: Speculative Demand and Capital Loss

17 Identify the correct statements regarding the competitive assets market condition:
I. The price of a bond must always be equal to its present value in equilibrium.
II. If the price rises above the present value, the bond becomes less attractive.
III. An increase in bond price indicates a corresponding increase in the market interest rate.

A I and II only

B II and III only

C I and III only

D I, II, and III

💡 Short Explanation

�� Equilibrium bond price equals present value. �� Overpriced bonds become unattractive. �� Bond prices and interest rates move inversely.

✅ Correct Answer Explanation

Statement I is correct because, in equilibrium, a bond's market price equals the present value of its future returns. Statement II is correct because if the market price exceeds its present value, investors will not prefer buying the bond, causing demand to fall. Statement III is incorrect because bond prices and market interest rates have an inverse relationship. An increase in bond price implies a fall—not a rise—in the market rate of interest. Therefore, Option A is correct.

❓ Why Other Options Are Incorrect

�� Option B → Statement III is incorrect.
�� Option C → Statement III is false.
�� Option D → Includes Statement III, which contradicts the inverse relationship.

🎯 Strategy

Used

Elimination

Application:

Identify the incorrect statement first and eliminate all options containing it.

Final Logic:

Since Statement III is false, only Option A remains.

🧠 Memory Trick

Bond ↑ = Interest ↓

📚 Class XII – Introductory Macroeconomics – Chapter: Money and Banking – Topic: Bond Pricing and Present Value

18 For a two-period bond that assures Rs 10 at the end of the first year and Rs 110 at the end of the second year, the present value of the stream of returns is calculated at a 5% interest rate. If the interest rate increases to 6%, what happens to the present value calculation?

A It remains exactly Rs 109.29.

B It increases beyond Rs 110.

C It decreases to approximately Rs 107.33.

D It becomes equal to the face value of Rs 100.

💡 Short Explanation

�� Present value falls when interest rates rise. �� Higher discount rates reduce current value. �� Bond prices and present values decrease.

✅ Correct Answer Explanation

The present value (PV) of future payments is calculated by discounting them at the prevailing market interest rate. At 6%, the present value becomes: PV = 10/(1.06) + 110/(1.06²) ≈ 9.43 + 97.90 ≈ 107.33 Since the discount rate has increased from 5% to 6%, the present value falls. Therefore, Option C is correct. Option A is the approximate value at 5%, not 6%. Option B contradicts the effect of a higher discount rate. Option D has no theoretical basis.

❓ Why Other Options Are Incorrect

�� Option A → Corresponds approximately to the present value at a 5% interest rate.
�� Option B → Present value cannot increase when the discount rate rises.
�� Option D → Present value is not automatically equal to the face value.

🎯 Strategy

Used

Substitution

Application:

Substitute the new interest rate into the present value formula.

Final Logic:

Higher Interest Rate → Lower Present Value.

🧠 Memory Trick

Discount ↑ = PV ↓

📚 Class XII – Introductory Macroeconomics – Chapter: Money and Banking – Topic: Present Value of Bonds

📄 Passage

"The aggregate money demand in an economy can be summarised by the equation:
Md = kPY + (r_max − r) / (r − r_min).
Here, r is the market rate of interest and r_max and r_min are the upper and lower limits of r. When r = r_min, the economy is in the liquidity trap. Everyone is sure of a future rise in interest rate and a fall in bond prices."

Based on the passage, what happens to the speculative demand for money when r reaches r_min?

A It becomes zero.

B It becomes infinite (perfectly elastic).

C It becomes equal to the transaction demand.

D It becomes negative.

💡 Short Explanation

�� Liquidity trap occurs at the minimum interest rate. �� Everyone expects future interest rates to rise. �� Speculative demand becomes perfectly elastic.

✅ Correct Answer Explanation

When r = r_min, the economy enters a liquidity trap. At this extremely low interest rate, people expect interest rates to increase in the future, which would reduce bond prices and generate capital losses. Consequently, everyone prefers to hold money rather than bonds. As a result, the speculative demand for money becomes perfectly elastic (effectively infinite). Therefore, Option B is correct. Option A is the opposite of what occurs. Option C is not implied by the passage. Option D is economically impossible.

❓ Why Other Options Are Incorrect

�� Option A → Speculative demand reaches its maximum, not zero.
�� Option C → There is no requirement that speculative demand equals transaction demand.
�� Option D → Money demand cannot become negative.

🎯 Strategy

Used

Contextual/Tonal Matching

Application:

Identify the economic implication directly stated in the passage regarding the liquidity trap.

Final Logic:

Liquidity Trap → Infinite Speculative Demand.

🧠 Memory Trick

Liquidity Trap = Everyone Holds Cash

📚 Class XII – Introductory Macroeconomics – Chapter: Money and Banking – Topic: Liquidity Trap

📄 Passage

Based on the passage equation for Md, which combination of variables directly impacts the total demand for money?

A Velocity of money and cash reserves only

B Bond maturity period and coupon rate only

C RBI repo rate and commercial bank profit margins

D Real GDP, price level, and the market rate of interest

💡 Short Explanation

�� Transaction demand depends on P and Y. �� Speculative demand depends on r. �� Together they determine total money demand.

✅ Correct Answer Explanation

From the equation: Md = kPY + (r_max − r)/(r − r_min) kPY represents transaction demand, which depends on: P = General price level Y = Real GDP The second term represents speculative demand, which depends on the market rate of interest (r). Thus, the total demand for money is directly influenced by: Real GDP General price level Market rate of interest Therefore, Option D is correct. Options A, B, and C do not contain all the variables included in the aggregate money demand equation.

❓ Why Other Options Are Incorrect

�� Option A → Velocity is related to money circulation, while cash reserves are not direct determinants in the given equation.
�� Option B → Bond maturity and coupon rate influence bond valuation but are not variables in the aggregate money demand equation.
�� Option C → Repo rate may influence market interest rates indirectly, but commercial bank profit margins are not determinants of money demand.

🎯 Strategy

Used

Option Grouping

Application:

Identify all variables explicitly appearing in the money demand equation.

Final Logic:

Money Demand = Function of P, Y, and r.

🧠 Memory Trick

Md = P + Y + r

📚 Class XII – Introductory Macroeconomics – Chapter: Money and Banking – Topic: Aggregate Demand for Money

CUET UG Economics Booster Test 2 - Demand for Money

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