Multiple choice

'Liquidity trap' refers to

  1. unitary elastic liquidity preference curve

  2. perfectly inelastic liquidity preference curve

  3. inelastic liquidity preference curve

  4. perfectly elastic liquidity preference curve
Reveal answer Fill a bubble to check yourself
D Correct answer
Explanation

Liquidity trap occurs when the liquidity preference curve becomes perfectly elastic (horizontal) at very low interest rates. People are indifferent between holding bonds and money, so monetary policy becomes ineffective. Unitary elastic, perfectly inelastic, and simply inelastic curves don't describe this situation.

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