1. According to the Classical Theory, the rate of interest is determined by:
A. Demand and supply of money only
B. Investment and savings equality in the short run
C. Demand and supply of capital (savings and investment)
D. Government monetary policy
Classical Theory states that the rate of interest is determined by the demand for capital (investment) and the supply of capital (savings).
2. Keynes’ Liquidity Preference Theory states that interest is a reward for:
A. Waiting to consume in the future
B. Sacrificing current consumption
C. Risk-taking ability of investors
D. Parting with liquidity (holding money)
According to Keynes, people demand money for liquidity, and interest is the reward for parting with liquidity.
3. In the Classical Theory, an increase in savings supply leads to:
A. Fall in interest rate
B. Rise in interest rate
C. No impact on interest rate
D. Increase in government borrowing
More savings mean higher supply of loanable funds, which reduces the equilibrium interest rate as per Classical Theory.
4. In Keynes’ theory, the transaction and precautionary motives of money demand are mainly influenced by:
A. Interest rate
B. Income level
C. Monetary policy of RBI
D. Savings-investment balance
According to Keynes, transaction and precautionary demand for money depend primarily on income, while speculative demand depends on interest rate.
5. Which criticism is often raised against the Classical Theory of Interest?
A. It explains interest only in terms of risk-taking
B. It focuses only on monetary policy actions
C. It assumes full employment, which is unrealistic
D. It ignores investment as a factor in determination of interest
The Classical Theory assumes full employment in the economy, which is considered unrealistic, especially during recessions.
6. In Keynes’ theory, the money demand curve (liquidity preference curve) is generally:
A. Downward sloping with respect to interest rate
B. Upward sloping with respect to income
C. Vertical at a fixed money supply
D. Horizontal at zero interest rate
The money demand curve is downward sloping with respect to the interest rate—higher interest rates reduce speculative demand for money, and vice versa.
7. The equilibrium rate of interest in the money market is determined at the point where:
A. Savings equals investment
B. Government expenditure equals tax revenue
C. Aggregate demand equals aggregate supply
D. Money demand equals money supply
The rate of interest in the money market is determined at the point where money demand (liquidity preference) equals money supply.
8. If the central bank reduces money supply while money demand remains unchanged, the equilibrium interest rate will:
A. Fall
B. Rise
C. Remain unchanged
D. First fall then rise
A reduction in money supply shifts the vertical money supply line leftward, creating excess demand for money, which pushes up the equilibrium interest rate.
9. At very low interest rates, the money demand curve becomes almost horizontal. This situation is known as:
A. Cost-push situation
B. Classical equilibrium
C. Liquidity trap
D. Inflationary gap
In a liquidity trap, people prefer holding money rather than bonds, making the demand curve almost flat, and monetary policy becomes ineffective in reducing interest rates further.
10. Suppose money demand is given by Md = 500 – 20r (where r is interest rate), and money supply is 300. What will be the equilibrium interest rate?
A. 10%
B. 8%
C. 12%
D. 15%
At equilibrium, Md = Ms → 500 – 20r = 300 → 20r = 200 → r = 10%. Hence, the equilibrium interest rate is 10%.
11. When the money supply increases while money demand remains unchanged, the equilibrium interest rate will:
A. Rise
B. Remain unchanged
C. Fall
D. First rise then fall
An increase in money supply shifts the vertical money supply line rightward, creating excess money supply at the old rate, which lowers the equilibrium interest rate.
12. A rightward shift in the money demand (liquidity preference) curve can occur due to:
A. Rise in income levels
B. Fall in transaction needs
C. Fall in precautionary motives
D. Increase in velocity of money
Higher income leads to greater transaction and precautionary demand for money, shifting the demand curve rightward.
13. If both money supply and money demand increase equally, the equilibrium interest rate will:
A. Fall sharply
B. Remain unchanged
C. Rise sharply
D. First fall then rise
If money demand and supply rise by the same magnitude, their effects offset each other, leaving the equilibrium rate of interest unchanged.
14. When the central bank increases money supply, the LM curve in the IS-LM model shifts:
A. Upward
B. Leftward
C. No shift occurs
D. Downward / Rightward
An increase in money supply reduces interest rates at each level of income, shifting the LM curve downward/rightward.
15. Which of the following would cause a leftward shift in the money demand curve?
A. Increase in GDP
B. Fall in income levels
C. Increase in precautionary balances
D. Rise in population
Lower income reduces the need for transactions and precautionary money holdings, shifting the demand curve leftward.
16. In the IS-LM model, the IS curve represents equilibrium in the:
A. Goods market
B. Money market
C. Labor market
D. Capital market
The IS curve shows combinations of interest rate and income where investment equals savings, i.e., equilibrium in the goods market.
17. The LM curve in the Hicks-Hansen model represents equilibrium in the:
A. Labor market
B. Capital market
C. Goods market
D. Money market
The LM curve shows equilibrium in the money market where demand for money equals supply of money at different income and interest rate levels.
18. The intersection of IS and LM curves determines:
A. Only the equilibrium rate of interest
B. Both equilibrium income and interest rate
C. Only the equilibrium level of income
D. Only the level of savings
The IS-LM intersection determines the simultaneous equilibrium in goods and money markets, giving both interest rate and income level.
19. A rightward shift of the IS curve can be caused by:
A. Decrease in government spending
B. Increase in taxes
C. Increase in investment demand or government expenditure
D. Fall in aggregate demand
Higher investment or government spending raises aggregate demand, shifting the IS curve rightward (outward).
20. In the IS-LM framework, an increase in money supply shifts the LM curve:
A. Upward
B. Leftward
C. No change occurs
D. Downward / Rightward
With higher money supply, at each income level the interest rate falls, so the LM curve shifts downward/rightward.
