econ 101 midterm 2

The equilibrium of the Keynesian cross shows:

equality of planned expenditure and income in the short run.

In this graph, assume that the economy starts at point A, and there is a favorable supply shock that does not last forever. In this situation, point _____ represents short-run equilibrium, and point _____ represents long-run equilibrium.

E; A

Using the Keynesian-cross analysis, assume that the consumption function is given by C = 200 + 0.7 (Y - T). If planned investment is 100 and T is 100, then the level of G needed to make equilibrium Y equal 1,000 is:

70.

if the interest rate is above the equilibrium value, the:

supply of real balances exceeds the demand.

Two interpretations of the IS-LM model are that the model explains:

the determination of income in the short run when prices are fixed or what shifts the aggregate demand curve.

The LM curve shows combinations of _____ that are consistent with equilibrium in the market for real money balances.

the interest rate and the level of income

The vertical long-run aggregate supply curve satisfies the classical dichotomy because the natural rate of output does NOT depend on:

the money supply.

If the short-run aggregate supply curve is horizontal, an increase in union aggressiveness that pushes wages and prices up will result in _____ prices and _____ output in the short run.

higher; lower

If a short-run equilibrium occurs at a level of output above the natural rate, then in the transition to the long run prices will _____, and output will _____.

increase; decrease

Assume that the economy starts at point A, and there is a drought that severely reduces agricultural output in the economy for just one year. In this situation, point _____ represents the short-run equilibrium immediately following the drought, and point _____ represents the eventual long-run equilibrium.

B; A

Explain the meaning of monetary neutrality and illustrate graphically that there is monetary neutrality in the long run in the aggregate demand-aggregate supply model. Be sure to label: i. the axes; ii. the curves; iii. the initial equilibrium values; iv. the direction the curves shift; v. the short-run equilibrium values; and vi. the long-run equilibrium values. Explain in words what your graph illustrates.

Monetary neutrality is the property that changes in money do not change real variables.

An increase in income raises money _____ and _____ the equilibrium interest rate.

demand; raises

A reduction in the money supply shifts the aggregate demand curve to the

left

Assume that the money demand function is (M / P)d = 2,200 - 200r, where r is the interest rate in percent. The money supply M is 2,000, and the price level P is 2. The equilibrium interest rate is _____ percent.

6

The economy of Macroland is initially in long-run equilibrium. A severe drought causes an adverse supply shock. a. What happens to prices and output in the short run? b. What would happen to prices and output in the long run if there is no policy accommodation? c. If the Central Bank of Macroland wants to prevent the short-run changes in price and output, what policy action could it take? How would the results of this policy action differ from the prices and output that would result in the long run with no policy action?

a. In the short run, prices increase, and output decreases. b. With no policy accommodation, both output and prices would return to their initial long-run equilibrium levels. c. The central bank could increase the money supply to return output to full employment, but this would result in a long-run equilibrium at a higher price level than the initial long-run equilibrium.

a. Suppose Congress passes legislation that significantly reduces taxes. Use the Keynesian-cross model to illustrate graphically the impact of a reduction in taxes on the equilibrium level of income. Be sure to label: i. the axes, ii. the curves, iii. the initial equilibrium values, iv. the direction the curve shifts, and v. the terminal equilibrium values. b. Explain in words what happens to equilibrium income as a result of the tax cut and the time horizon appropriate for this analysis.

a. graph b. The equilibrium level of income increases. This analysis is appropriate in the short run when prices and the interest rate are constant.

Short-run fluctuations in output and employment are called:

business cycles.

The intersection of the IS and LM curves determines the values of:

r and Y, given G, T, M, and P.

"Full employment" means that

unemployment equals its natural rate (not zero).

A decrease in the real money supply, other things being equal, will shift the LM curve:

upward and to the left.