Practice Quiz

Praxis II Social Sciences Content Knowledge Exam Prep

Category - Macroeconomics

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In Keynesian economics, “liquidity trap” refers to instances when demand for money becomes inelastic, which means that further introduction of money into the economy will not lower interest rates. What is the shape of a demand curve during a liquidity trap?
  1. Horizontal
  2. Vertical
  3. Concave
  4. Convex
Explanation
Answer - A - A demand curve during a liquidity trap is horizontal.

Key Takeaway: During a liquidity trap, increased infusions of money into the economy do not serve to lower interest rates. This leads to the demand curve becoming horizontal. In such cases, monetary policies will not serve to stimulate an economy that is slowed down by high interest rates.
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