Question

According to the theory of liquidity preference, if the demand for real money balances exceeds the supply of real money balances, individuals will: purchase interest-earning assets in order to reduce holdings of non-interest-bearing money. sell interest-earning assets in order to obtain non-interest-bearing money. purchase fewer goods and services. be content with their portfolios.

Answer 1

sell interest-earning assets in order to obtain non-interest-bearing money

Step-by-step explanation:

As per theory of liquidity preference : Money markets are at equilibrium when - market demand for transaction, precautionary, speculative purpose is equal to institutionally determined money supply.

• Money supply is constant, fixed by government. It is inelastic (vertical) with regards to interest.
• Money speculative demand is only related to interest rate, it is negatively related. As, Higher interest rate means people would like to hold less liquid money (higher interest rate sacrifised opportunity cost). Vice versa, lower interest rates imply high liquid money demand.

When demand for money balances > supply for money balances, or interest rate < equilibrium interest rate. People will sell their securities, to hold more money.