Question

Given below are two statements, one is labelled as Assertion (A) and other one labelled as Reason (R).
Assertion (A): According to Keynes, an individual's aggregate demand to hold money is composed of Transaction Demand, Precautionary Demand and Speculative Demand.
Reason (R): The Speculative Demand for money is a direct and positive function of the level of money income.
In light of the above statements, choose the correct answer from the options given below.

• A. Both (A) and (R) are true and (R) is the correct explanation of (A).
• B. Both (A) and (R) are true but (R) is NOT the correct explanation of (A).
• C. (A) is true but (R) is false.
• D. (A) is false but (R) is true.

Hint:

Remember the functional relationships in Keynesian money demand:
- Transaction and Precautionary demands depend on Income ($Y$).
- Speculative demand depends inversely on the Rate of Interest ($r$).

Answer 1

The Correct Option is C

Step 1: Understanding the Concept:
Keynesian Liquidity Preference Theory explains why individuals hold cash balances.
Keynes identified three primary motives for holding money: transaction, precautionary, and speculative motives.

Step 2: Detailed Explanation:
Let us evaluate both statements:
- Assertion (A):
Keynes formulated that the total demand for money ($M^d$) is the sum of three demands:
1. Transaction demand ($M_t$)
2. Precautionary demand ($M_p$)
3. Speculative demand ($M_s$)
Thus, $M^d = M_t + M_p + M_s$. This statement is true.
- Reason (R):
According to Keynesian theory, transaction and precautionary demands ($M_t$ and $M_p$) are direct and positive functions of the level of money income ($Y$):
\[ M_t + M_p = f(Y) \] However, the speculative demand for money ($M_s$) is a demand for cash balances to exploit interest rate movements.
It is primarily a function of the rate of interest ($r$), with which it has an inverse (negative) relationship:
\[ M_s = f(r) \quad \text{where } \frac{dM_s}{dr} < 0 \] Speculative demand is not a direct and positive function of the level of money income. Thus, Reason (R) is false.
Since Assertion (A) is true and Reason (R) is false, Option (C) is correct.

Step 3: Final Answer:
The correct option is (C).