Question

What would happen if there was only the transaction motive behind the demand for money? In other words, what would happen if the demand for money only depended on income? a. Monetary policy would be ineffective in boosting aggregate demand. O b. None of the alternatives is correct. O c. Fiscal policy would only affect interest rate. Od. There would be no crowding out effect. e. The LM curve would be horizontal.

Answer 1

If there was only the transaction motive behind the demand for money, monetary policy would be ineffective in boosting aggregate demand, there would be no crowding out effect from fiscal policy, and the LM curve would be horizontal.

Step-by-step explanation:

In a scenario where there is only the transaction motive behind the demand for money, meaning the demand for money only depends on income, several implications can be observed:

1. Monetary policy would be ineffective in boosting aggregate demand: Since the demand for money is solely based on income, changes in interest rates or the money supply would not have any impact on the demand for money. Therefore, monetary policy tools, such as adjusting interest rates or conducting open market operations, would not be effective in stimulating aggregate demand.
2. There would be no crowding out effect: The crowding out effect refers to the reduction in private sector spending due to increased government borrowing. In a scenario where the demand for money only depends on income, fiscal policy would not affect interest rates and, therefore, would not lead to a crowding out effect.
3. The LM curve would be horizontal: In the IS-LM model, the LM curve represents the equilibrium in the money market. In a situation where the demand for money depends solely on income, the LM curve would be horizontal because any change in income would not affect the demand for money.

Answer 2

If the demand for money only depended on income for transaction purposes, monetary policy aimed at changing interest rates would be ineffective in influencing aggregate demand since money demand would not respond to interest rate changes.

Step-by-step explanation:

If the demand for money depended only on income, or the transaction motive, it would mean that individuals and businesses only hold money for spending and not for speculative or precautionary reasons. In this scenario, a key implication would be that monetary policy would become less effective in influencing aggregate demand through interest rate manipulation. Normally, monetary policy can adjust interest rates to encourage or discourage investment and consumption. However, if the transaction motive were the sole reason for holding money, changes in interest rates would have little to no impact on the quantity of money people want to hold.

Under the assumption of this scenario, the correct answer to the student's multiple-choice question would likely be Option A 'Monetary policy would be ineffective in boosting aggregate demand.' Because the demand for money does not respond to changes in interest rates, the standard transmission mechanisms of monetary policy would be disrupted, limiting its effectiveness. However, since this assumption deviates significantly from how money demand is commonly understood (with speculative and precautionary motives included), it's important to think critically about such scenarios.