Question 58

Quantity of money demanded varies inversely with nominal interest rate.

The quantity of money demanded decreases as nominal interest rates increase. This reflects the opportunity cost of holding money; when interest rates rise, the cost of forgoing interest earnings on investments increases, leading individuals to hold less cash.

A) directly with nominal GDP

This option is incorrect because the quantity of money demanded does not directly relate to nominal GDP. While higher nominal GDP can lead to increased transactions and therefore a higher demand for money, it is the interest rate that primarily influences how much money individuals choose to hold at any given time.

B) inversely with nominal interest rate

This option is correct as it directly aligns with the economic principle that higher nominal interest rates lead to a lower quantity of money demanded. As individuals and businesses seek to maximize their returns, they tend to hold less cash when interest rates are elevated.

C) directly with price level

This option is incorrect because while the quantity of money demanded can rise with an increase in the price level (as more money is needed for transactions), it does not address the relationship with nominal interest rates. The demand for money is more closely tied to interest rates than to price levels in this context.

D) inversely with real GDP

This option is incorrect as well, since real GDP typically indicates economic growth and increased transactions, which would increase the demand for money rather than decrease it. The relationship specified here does not accurately reflect how money demand operates in relation to economic activity.

Conclusion

The correct answer identifies the fundamental relationship between the quantity of money demanded and nominal interest rates, highlighting that higher rates discourage cash holding. Other options fail to accurately capture this inverse relationship, focusing instead on different economic variables that do not primarily dictate money demand.