Question : Which of the following statements is/are correct regarding the liquidity trap?
i. It is where speculative demand for money is infinitely inelastic and the liquidity preference curve becomes perfectly elastic.
ii. It is where speculative demand for money is infinitely elastic and the liquidity preference curve becomes perfectly inelastic.
iii. It is the point where speculative demand for money is infinitely elastic and the liquidity preference curve becomes perfectly elastic.
iv. It is the point where speculative demand for money and the liquidity preference curves are not related.
Option 1: Only Statement ii is correct
Option 2: Only Statement iii is correct
Option 3: Only Statement iv is correct
Option 4: Only Statements i and ii are correct
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Correct Answer: Only Statement iii is correct
Solution : The correct option is Only statement iii is correct .
The liquidity preference curve is completely inelastic in a liquidity trap because people are unwilling to invest or spend their money and have a strong desire to cling to it, making the speculative demand for money excessively elastic. This is usually the case when traditional monetary policy tools become ineffective, and nominal interest rates are at or close to zero.
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