The correct option is 1 and 3 only.
Explanation
The demand for money is influenced by the trade-off between the benefit of liquidity (ease of use for transactions) and the cost of holding an asset that yields no return. This cost is known as the opportunity cost of holding money.
Statement 1 is Correct:
The opportunity cost of holding money is defined as the interest income foregone by keeping wealth in the form of liquid cash rather than in interest-bearing assets such as bonds, fixed deposits, or government securities. Since cash generally earns zero interest, the cost of holding it is the return one would have earned elsewhere.
Statement 2 is Incorrect:
There is a direct relationship between interest rates and the opportunity cost of holding money. When interest rates rise, the return on alternative assets (like bonds) increases. Consequently, the loss incurred by holding idle cash becomes greater. Therefore, as the interest rate rises, the opportunity cost of holding money increases, not decreases.
Statement 3 is Correct:
Individuals and firms constantly weigh the advantage of having liquidity (to meet daily transactions and unforeseen expenses) against the opportunity cost (the interest income sacrificed). If the opportunity cost is low (low interest rates), the preference for liquidity tends to be higher; if the opportunity cost is high, agents minimize their cash holdings.
Key Takeaway:
The demand for money is inversely related to the market interest rate. A higher interest rate increases the opportunity cost of holding money, thereby reducing the demand for speculative money balances.