What liquidity means
Not "lots of volume". Liquidity is the ability to trade a given size quickly without moving the price much. An instrument with high volume but a thin order book can be illiquid in the way that matters.
The practical measures: spread width, depth at the touch, and how quickly the book refills after a trade.
Market impact
Executing a large order moves the price against you. Buying consumes offers, and the price you pay on average is worse than the price you saw.
The widely used empirical regularity is the square-root law: impact scales roughly with the square root of order size relative to daily volume.
Impact ≈ k times volatility times sqrt(Q / V)
Doubling your order size increases impact by about 40%, not 100%. That sub-linearity is why execution can be improved but not eliminated.
Temporary versus permanent
Temporary impact is the cost of demanding immediacy - you consumed liquidity and the book refills, so the price reverts. This part can be reduced by trading slower.
Permanent impact is the market updating its beliefs because your trade carried information. This does not revert, and it cannot be avoided by trading slower - only by being less predictable.
Distinguishing these is what separates a good answer from a vague one.
The execution trade-off
Trade fast and you pay impact. Trade slowly and you take timing risk - the price may move away from you for unrelated reasons while you are still working the order.
The optimal schedule balances the two, which is the substance of the Almgren-Chriss framework. The qualitative result: more urgency when volatility is high, more patience when impact is high.
Why market makers care
Their entire business is being paid for supplying immediacy. The spread they charge is compensation for the impact and adverse selection they absorb by taking the other side.
In the interview
Questions here are often Fermi-flavoured: "how much would it cost to buy 5% of a company's daily volume?" Use the square-root law, state the assumption, and give a range.
Practise in market making.