Why do economists study the money supply, particularly with regard to liquidity?

• A. Because the money supply affects the liquidity in the economy, which influences spending, investment, and overall economic activity.
• B. Because the money supply only affects the production of goods and services, not liquidity.
• C. Because the money supply is unrelated to liquidity and only impacts international trade.
• D. Because the money supply determines the level of government spending in the economy.

Answer: (A)

Verified step by step guidance

1. Step 1: Understand the concept of money supply. The money supply refers to the total amount of monetary assets available in an economy at a specific time, including cash, coins, and balances in checking and savings accounts.
2. Step 2: Define liquidity. Liquidity is the ease with which assets can be converted into cash or used for transactions without losing value. Money is considered the most liquid asset.
3. Step 3: Explain the relationship between money supply and liquidity. When the money supply increases, more liquid assets are available in the economy, making it easier for individuals and businesses to spend and invest.
4. Step 4: Connect liquidity to economic activity. Higher liquidity facilitates spending and investment, which are key drivers of production, employment, and overall economic growth.
5. Step 5: Conclude why economists study money supply with regard to liquidity. Economists focus on money supply because changes in liquidity influence economic behavior and outcomes, such as consumption, investment, and the health of the economy.