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Liquidity preference refers to the desire to hold money rather than
other forms of wealth such as stocks and bonds. Liquidity preference
can be thought of as stemming from the following sources:
(i) The precautionary motive
This relates to the factor that causes people
or firms to hold a stock of money in order to finance unforeseen
expenditures such as illness or a car breakdown. These aspects of
demand for money is also likely to depend on the level of money
income. It may, in addition, be influenced by the rate of interest.
(ii) The speculative motive
This relates to the reason which causes people
or firms to hold money in the belief that a capital gain or the avoidance
of a loss can be achieved by doing so. Thus, for example, when the
price of a bond falls, the attraction of holding them increases since
people will expect their price to rise again such that anyone owing
them can make a capital gain. When the price of bonds is high, on the
other hand, they will believe that their price could fall and will
therefore hold more money.
(iii) Transactionary demand
This relates to the holding of cash by people or firms in order to
finance foreseeable expenditures. The amount of money held for
this purpose depends on the individuals money income, and
institutional arrangements such as how frequently the individual is paid.
Dullayo answered the question on September 18, 2020 at 19:17
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