EC 171 EXAM 3 PRACTICE EXAM

The U.S. recession of 2001 can be explained in part by a declining stock market and terrorist attacks. Both of these shocks can be represented in the IS- LM model by shifting the ______ curve to the ______. -LM; right -IS; left -LM; left -IS; right

IS; left

The version of Okun's law studied in Chapter 10 assumes that with no change in unemployment, real GDP normally grows by 3 percent over a year. If the unemployment rate rose by 2 percentage points over a year, Okun's law predicts that real GDP would: -increase by 1 percent. -decrease by 1 percent. -decrease by 3 percent. -decrease by 2 percent.

decrease by 1 percent.

According to the Keynesian-cross analysis, if MPC stands for marginal propensity to consume, then a rise in taxes of Δ T will: -not affect equilibrium income at all. -decrease equilibrium income by ΔT -decrease equilibrium income by ΔT / (1 - MPC). -decrease equilibrium income by ΔT (MPC) / (1 - MPC).

decrease equilibrium income by ΔT (MPC) / (1 - MPC).

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. -decrease; IS -increase; LM -decrease; LM -increase; IS

decrease; LM

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. -decrease; decrease; decrease; decrease -decrease; decrease; increase; increase -increase; increase; increase; increase -increase; increase; decrease; decrease

decrease; decrease; decrease; decrease

An explanation for the slope of the IS curve is that as the interest rate increases, the quantity of investment ______, and this shifts the expenditure function ______, thereby decreasing income. -decreases; downward -decreases; upward -increases; downward -increases; upward

decreases; downward

A favorable supply shock ______ the short-run aggregate supply curve ______ the natural level of output. -lowers; and may also increase -raises; and may also increase -raises; but cannot affect -lowers; but cannot affect

lowers; and may also increase

Long-run growth in real GDP is determined primarily by ______, while short-run movements in real GDP are associated with ______. -money supply growth rates; changes in velocity -changes in velocity; money supply growth rates -technological progress; variations in labor-market utilization -variations in labor-market utilization; technological progress

technological progress; variations in labor-market utilization

Exhibit: Supply Shock 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. -B; C -E; D -E; A -B; A

E; A

Changes in fiscal policy shift the: -money supply curve. -money demand curve. -LM curve. -IS curve.

IS curve.

A tax cut shifts the ______ curve to the right, and the aggregate demand curve ______. -LM; does not shift -IS; does not shift -LM; shifts to the right -IS; shifts to the right

IS; shifts to the right

Assume that the money demand function is ( M / P) d = 2,200 - 200 r, where ris the interest rate in percent. If the price level is fixed at P=2, and the Fed wants to fix the interest rate at 7 percent, it should set the money supply at: -1,800. -1,400. -2,000. -1,600.

1,600

In the Keynesian-cross analysis, if the consumption function is given by C = 100 + 0.6( Y - T), and planned investment is 100, G is 100, and T is 100, then equilibrium Y is: -400. -750. -600. -350.

600.

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. lower; raises; reduces -higher; lowers; increases -higher; raises; reduces -lower; lowers; increases

lower; raises; reduces

If the short-run aggregate supply curve is horizontal and the long-run aggregate supply curve is vertical, then a change in the money supply will change ______ in the short run and change ______ in the long run. -both prices and output; only prices -both prices and output; both prices and output -only output; only prices -only prices; only output

only output; only prices

Assume that the economy begins in long-run equilibrium. Then the Fed reduces the money supply. In the short run ______, whereas in the long run prices ______ and output returns to its original level. -output decreases and prices are unchanged; fall -output and prices both decrease; rise -output and prices both decrease; fall -output decreases and prices are unchanged; rise

output decreases and prices are unchanged; fall

If the long-run aggregate supply curve is vertical, then changes in aggregate demand affect: -neither prices nor level of output. -both prices and level of output. -level of output but not prices. -prices but not level of output.

prices but not level of output.

In the Keynesian-cross model, what adjusts to move the economy to equilibrium following a change in exogenous planned spending? -the price level -the interest rate -planned spending -production

production

Exhibit: Keynesian Cross In this graph, if firms are producing at level Y 3, then inventories will ______, inducing firms to ______ production. -fall; decrease -fall; increase -rise; increase -rise; decrease

rise; 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 ______. -rises; falls -rises; rises -falls; falls -falls; rises

rises; falls

Exhibit: Market for Real Money Balances Based on the graph, if the interest rate is r 3, then people will ______ bonds, and the interest rate will ______. -buy; fall -buy; rise -sell; rise -sell; fall

sell; rise

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): -contractionary shift in the IS curve. -expansionary shift in the IS curve. -contractionary shift in the LM curve. -expansionary shift in the LM curve.

contractionary shift in the IS curve.

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

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

Exhibit: Policy Interaction Based on the graph, starting from equilibrium at interest rate r 3, income Y 2, IS1, and LM 1, if there is an increase in government spending that shifts the IScurve to IS 2, then in order to keep the interest rate constant, the Federal Reserve should _____ the money supply, shifting to _____. -increase; LM2 -decrease; LM3 -decrease; LM2 -increase; LM3

increase; LM2

In the Keynesian-cross model, a decrease in the interest rate ______ planned investment spending and ______ the equilibrium level of income. -decreases; increases -decreases; decreases -increases; decreases -increases; increases

increases; increases

Exhibit: Short Run to Long Run Based on the graph, if the economy starts from a short-term equilibrium at A, then the long-run equilibrium will be at ____, with a _____ price level. -B; lower -B; higher -C; higher -C; lower

B; lower

Exhibit: Shift in Aggregate Demand In this graph, initially the economy is at point E, with price P 0 and output aggregate demand is given by curve AD 0, and SRAS and LRAS represent, respectively, short-run and long-run aggregate supply. Now assume that the aggregate demand curve shifts so that it is represented by AD 1. The economy moves first to point ______ and then, in the long run, to point ______. -D; A -A; D -C; B -B; C

C; B

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: -by raising the interest rate so that investment spending increases. -directly. -by lowering the interest rate so that investment spending increases. -by increasing government spending on goods and services.

by lowering the interest rate so that investment spending increases.

In the IS- LM model, which two variables are influenced by the interest rate? -supply of nominal money balances and investment spending -demand for real money balances and investment spending -supply of nominal money balances and demand for real balances -demand for real money balances and government purchases

demand for real money balances and investment spending

When an aggregate demand curve is drawn with real GDP ( Y) along the horizontal axis and the price level ( P) along the vertical axis, if the money supply is decreased, then the aggregate demand curve will shift: -downward and to the left. -downward and to the right. -upward and to the right. -upward and to the left.

downward and to the left.

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: -investment is autonomous, whereas in the IS-LM model fiscal expansion encourages higher investment, which raises the interest rate. -investment is not affected by the interest rate, whereas in the IS-LM model fiscal expansion raises the interest rate and crowds out investment. -the price level is fixed, whereas in the IS-LM model it is allowed to vary. -investment is not affected by the interest rate, whereas in the IS-LM model fiscal expansion lowers the interest rate and crowds out investment.

investment is not affected by the interest rate, whereas in the IS-LMmodel fiscal expansion raises the interest rate and crowds out investment.

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

investment rises but consumption falls.

According to the theory of liquidity preference, the supply of real money balances: -is fixed by the central bank. -increases as income increases. -decreases as the interest rate increases. -increases as the interest rate increases.

is fixed by the central bank.

If the Fed accommodates an adverse supply shock, output falls ______, and prices rise ______. more; more -less; less -more; less -less; more

less; more

In the Keynesian-cross model, if the MPC equals 0.75, then a $1 billion increase in government spending increases planned expenditures by ______ and increases the equilibrium level of income by ______. -$0.75 billion; more than $0.75 billion -$1 billion; $1 billion -$0.75 billion; $0.75 billion -$1 billion; more than $1 billion

$1 billion; more than $1 billion

If the IS curve is given by Y = 1,700 - 100 r, the money demand function is given by ( M/ P) d = Y - 100 r, 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: -100 and the interest rate falls by 1 percent. -200 and the interest rate falls by 2 percent. -50 and the interest rate falls by 0.5 percent. -200 and the interest rate remains unchanged.

50 and the interest rate falls by 0.5 percent.

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

IS curve downward and to the left.

When planned expenditure is drawn on a graph as a function of income, the slope of the line is: -one. -greater than one. -between zero and one. -between minus one and zero.

between zero and one.

Short-run fluctuations in output and employment are called: -business cycles. -productivity slowdowns. -the classical dichotomy. -sectoral shifts.

business cycles.

According to the theory of liquidity preference, holding the supply of real money balances constant, an increase in income will ______ the demand for real money balances and will ______ the interest rate. -decrease; increase -increase; decrease -increase; increase -decrease; decrease

increase; increase

An IS curve shows combinations of: -nominal money balances and price levels. -taxes and government spending. -interest rates and income that bring equilibrium in the market for real balances. -interest rates and income that bring equilibrium in the market for goods and services.

interest rates and income that bring equilibrium in the market for goods and services.

An increase in the money supply: -increases income and lowers the interest rate in both the short run and in the long run. -lowers the interest rate and increases income in the short run but leaves both unchanged in the long run. -lowers the interest rate in both the short run and in the long run but leaves income unchanged in the long run. -increases income in both the short run and in the long run but leaves the interest rate unchanged in the long run.

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

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. -horizontal; vertical -movement along the; shift in the -vertical; horizontal -shift in the; movement along the

movement along the; shift in the

The IS curve plots the relationship between the interest rate and ______ that arises in the market for ______. -the price level; money. -national income; money -the price level; goods and services -national income; goods and services

national income; goods and services

The intersection of the IS and LM curves determines the values of: -r, Y, and M, given G, T, and P. -r, Y, and P, given G, T, and M. -p and Y, given G, T, and M. -r and Y, given G, T, M, and P.

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

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

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

Monetary neutrality is a characteristic of the aggregate demand-aggregate supply model in: -the short run but not in the long run. -the long run but not in the short run. -both the short run and the long run. -neither the short run nor the long run.

the long run but not in the short run.

The IS-LM model takes ______ as exogenous. -the price level -the interest rate -national income -the price level and national income

the price level

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

usually less than

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

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