Problem Set 6

The reason that the income response to a fiscal expansion is generally less in the IS-LM model than it is in the Keynesian-cross model is that the Keynesian-cross model assumes that: A) investment is not affected by the interest rate whereas in the IS-LM model fiscal expansion raises the interest rate and crowds out investment. B) investment is not affected by the interest rate whereas in the IS-LM model fiscal expansion lowers the interest rate and crowds out investment. C) investment is autonomous whereas in the IS-LM model fiscal expansion encourages higher investment, which raises the interest rate. D) the price level is fixed whereas in the IS-LM model it is allowed to vary.

A) investment is not affected by the interest rate whereas in the IS-LM model fiscal expansion raises the interest rate and crowds out investment.

In the IS-LM analysis, the increase in income resulting from a tax cut is usually ______ the increase in income resulting from an equal rise in government spending. A) less than B) greater than C) equal to D) sometimes less and sometimes greater than

A) less than

The Phillips curve analysis implies that there is a negative tradeoff between inflation and unemployment in: A) both the short run and long run. B) in the short run only. C) in the long run only. D) in neither the short run nor the long run.

B) in the short run only.

If the short-run IS-LM equilibrium occurs at a level of income below the natural level of output, then in the long run the price level will ______, shifting the ______ curve to the right and returning output to the natural level. A) increase; IS B) decrease; IS C) increase; LM D) decrease; LM

D) decrease; LM

A tax cut shifts the ______ to the right, and the aggregate demand curve ______. A) IS; shifts to the right B) IS; does not shift C) LM: shifts to the right D) LM; does not shift

A) IS; shifts to the right

Changes in monetary policy shift the: A) LM curve. B) planned spending curve. C) money demand curve. D) IS curve.

A) LM curve.

In the IS-LM model, a decrease in government purchases leads to a(n) ______ in planned expenditures, a(n) ______ in total income, a(n) ______ in money demand, and a(n) ______ in the equilibrium interest rate. A) decrease; decrease; decrease; decrease B) increase; increase; increase; increase C) decrease; decrease; increase; increase D) increase; increase; decrease; decrease

A) decrease; decrease; decrease; decrease

In the IS-LM model when M remains constant but P rises, in short-run equilibrium, in the usual case the interest rate ______ and output ______. A) rises; falls B) rises; rises C) falls; rises D) falls; falls

A) rises; falls

In the IS-LM model when M remains constant but P rises, in short-run equilibrium, the interest rate ______ and output ______. A) rises; falls B) rises; rises C) falls; rises D) falls; falls

A) rises; falls

If the demand function for money is M/P = 0.5Y - 100r, then the slope of the LM curve is: A) 0.001. B) 0.005. C) 0.01. D) 0.05.

B) 0.005. solve for r -100r=(M/P)-.5Y r=(.5Y/100)-(M/P)/100 r=.005Y-(M/P)/100

The imperfect-information model assumes that producers find it difficult to distinguish between changes in: A) real wages and nominal wages. B) the overall level of prices and relative prices. C) the overall level of prices and the expected level of prices. D) cost-push inflation and demand-pull inflation.

B) the overall level of prices and relative prices.

An increase in government spending generally shifts the IS curve, drawn with income along the horizontal axis and the interest rate along the vertical axis: A) downward and to the left. B) upward and to the right. C) upward and to the left. D) downward and to the right.

B) upward and to the right.

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. If the price level is fixed and the Fed wants to fix the interest rate at 7 percent, it should set the money supply at: A) 2,000. B) 1,800. C) 1,600. D) 1,400.

C) 1,600. solve for M

If the IS curve is given by Y = 1,700 - 100r, the money demand function is given by (M/P)d = Y - 100r, the money supply is 1,000, and the price level is 2, then if the money supply is raised to 1,200, equilibrium income rises by: A) 200 and the interest rate falls by 2 percent. B) 100 and the interest rate falls by 1 percent. C) 50 and the interest rate falls by 0.5 percent. D) 200 and the interest rate remains unchanged.

C) 50 and the interest rate falls by 0.5 percent.

An increase in consumer saving for any given level of income will shift the: A) LM curve upward and to the left. B) LM curve downward and to the right. C) IS curve downward and to the left. D) IS curve upward and to the right.

C) IS curve downward and to the left.

One policy response to the U.S. economic slowdown of 2001 was tax cuts. This policy response can be represented in the IS-LM model by shifting the ______ curve to the ______. A) LM; right B) LM; left C) IS; right D) IS; left

C) IS; right

An increase in the money supply shifts the ______ curve to the right, and the aggregate demand curve ______. A) IS; shifts to the right B) IS; does not shift C) LM: shifts to the right D) LM; does not shift

C) LM: shifts to the right

In the IS-LM model, a decrease in output would be the result of a(n): A) decrease in taxes. B) increase in the money supply. C) increase in money demand. D) increase in government purchases.

C) increase in money demand.

The interest rate determines ______ in the goods market and money ______ in the money market. A) government spending; demand B) government spending; supply C) investment spending; demand D) investment spending; supply

C) investment spending; demand

An increase in the money supply: A) increases income and lowers the interest rate in both the short and long runs. B) increases income in both the short and long runs, but leaves the interest rate unchanged in the long run. C) lowers the interest rate in both the short and long runs, but leaves income unchanged in the long run. D) lowers the interest rate and increases income in the short run, but leaves both unchanged in the long run.

D) lowers the interest rate and increases income in the short run, but leaves both unchanged in the long run.

All of the following events are consistent with the spending hypothesis as contributing to the Great Depression except: A) the decline in investment spending on housing because of a decline in immigration in the 1930s. B) the decline in consumption spending caused by the stock market crash of 1929. C) fiscal policy to reduce the budget deficit by raising taxes in 1932. D) the 25-percent reduction in the money supply between 1929 and 1933.

D) the 25-percent reduction in the money supply between 1929 and 1933.

The interaction of the IS curve and the LM curve together determine: A) the price level and the inflation rate. B) the interest rate and the price level. C) investment and the money supply. D) the interest rate and the level of output.

D) the interest rate and the level of output.

If Congress passed a tax increase at the request of the president to reduce the budget deficit, but the Fed held the money supply constant, then the two policies together would generally lead to ______ income and a ______ interest rate. A) lower; lower B) lower; higher C) no change in; lower D) no change in; higher

A) lower; lower

The aggregate demand curve generally slopes downward and to the right because, for any given money supply M a higher price level P causes a ______ real money supply M/P, which ______ the interest rate and ______ spending. A) lower; raises; reduces B) higher; lowers; increases C) lower; lowers; increases D) higher; raises; reduces

A) lower; raises; reduces

A change in income in the IS-LM model resulting from a change in the price level is represented by a ______ aggregate demand curve, while a change in income in the IS-LM model for a given price level is represented by a ______ aggregate demand curve. A) movement along the; shift in the B) shift in the; movement along the C) vertical; horizontal D) horizontal; vertical

A) movement along the; shift in the

Along a short-run aggregate supply curve, output is related to unexpected movements in the ______. Along a Phillips curve, unemployment is related to unexpected movements in the ______. A) price level; inflation rate B) inflation rate; price level C) unemployment rate; price level D) price level; level of output

A) price level; inflation rate

An increase in the interest rate: A) reduces planned investment, because the interest rate is the cost of borrowing to finance investment projects. B) increases planned investment, because people who make money from interest have more money to invest. C) has no effect on investment. D) may be caused by a drop in investment demand.

A) reduces planned investment, because the interest rate is the cost of borrowing to finance investment projects.

The monetary transmission mechanism in the IS-LM model is a process whereby an increase in the money supply increases the demand for goods and services: A) directly. B) by lowering the interest rate so that investment spending increases. C) by raising the interest rate so that investment spending increases. D) by increasing government spending on goods and services.

B) by lowering the interest rate so that investment spending increases.

During the financial crisis of 2008-2009, many financial institutions stopped making loans even to creditworthy customers, which could be represented in the IS-LM model as a(n): A) expansionary shift in the IS curve. B) contractionary shift in the IS curve. C) expansionary shift in the LM curve. D) contractionary shift in the LM curve.

B) contractionary shift in the IS curve.

According to the IS-LM model, when the government increases taxes and government purchases by equal amounts: A) income, the interest rate, consumption, and investment are unchanged. B) income and the interest rate rise, whereas consumption and investment fall. C) income and the interest rate fall, whereas consumption and interest rise. D) income, the interest rate, consumption, and investment all rise.

B) income and the interest rate rise, whereas consumption and investment fall.

In the IS-LM model, the impact of an increase in government purchases in the goods market has ramifications in the money market, because the increase in income causes a(n) ______ in money ______. A) increase; supply B) increase; demand C) decrease; supply D) decrease; demand

B) increase; demand

An increase in investment demand for any given level of income and interest rates—due, for example, to more optimistic "animal spirits"—will, within the IS-LM framework, ______ output and ______ interest rates. A) increase; lower B) increase; raise C) lower; lower D) lower; raise

B) increase; raise

Along an aggregate supply curve, if the level of output is less than the natural level of output, then the price level is: A) greater than the expected price level. B) less than the expected price level. C) equal to the natural price level. D) stuck at the existing price level.

B) less than the expected price level.

The macroeconomic model may be completed by adding either the Keynesian assumption that ______ or the classical assumption that ______. A) output is fixed; prices are fixed B) prices are fixed; output is fixed C) the interest rate is fixed; the money supply is fixed D) prices are flexible; output varies

B) prices are fixed; output is fixed

If taxes are raised, but the Fed prevents income from falling by raising the money supply, then: A) both consumption and investment remain unchanged. B) consumption rises but investment falls. C) investment rises but consumption falls. D) both consumption and investment fall.

C) investment rises but consumption falls.

The Keynesian-cross analysis assumes planned investment: A) is fixed and so does the IS analysis. B) depends on the interest rate and so does the IS analysis. C) is fixed, whereas the IS analysis assumes it depends on the interest rate. D) depends on expenditure and so does the IS analysis.

C) is fixed, whereas the IS analysis assumes it depends on the interest rate.

In the IS-LM model, the multiplier for an increase in government spending is ______ for an increase in government purchases using the Keynesian-cross analysis. A) larger than the multiplier B) the same as the multiplier C) smaller than the multiplier D) sometimes larger and sometimes smaller than the multiplier

C) smaller than the multiplier

According to the Keynesian-cross analysis, when there is a shift upward in the government- purchases schedule by an amount ΔG and the planned expenditure schedule by an equal amount, then equilibrium income rises by: A) one unit. B) ΔG. C) ΔG divided by the quantity one minus the marginal propensity to consume. D) ΔG multiplied by the quantity one plus the marginal propensity to consume.

C) ΔG divided by the quantity one minus the marginal propensity to consume.

Using the Keynesian-cross analysis, assume that the consumption function is given by C = 100 + 0.6(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: A) 200. B) 240. C) 250. D) 260.

D) 260. solve for G

Analysis of the short and long runs indicates that the ______ assumptions are most appropriate in ______. A) classical; both the short and long runs. B) Keynesian; both the short and long runs. C) classical; the short run, whereas the Keynesian assumptions are most appropriate in the long run. D) Keynesian; the short run, whereas the classical assumptions are most appropriate in the long run.

D) Keynesian; the short run, whereas the classical assumptions are most appropriate in the long run.