EC 171 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 _________.

IS; left

According to the Keynesian-cross analysis, when there is a shift upward in the government-purchases schedule by an amount change in G and the planned expenditure schedule by an equal amount, then equilibrium income rises by:

change in G divided by the quantity one minus the marginal propensity to consume

If a 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; 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

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

An increase in the money supply

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

A favorable supply shock ______ the short-run aggregate supply curve _________ the natural level of output.

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 ____________.

technological progress; variations in labor-market utilization

All of the following events are consistent with the spending hypothesis as contributing to the Great Depression except:

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

A tax cut shifts the ______ curve to the right, and the aggregate demand curve ___________.

IS; shifts 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 supply of money is raised to 2,800, then the equilibrium interest rate will:

1,600

If the IS curve is given by Y = 1,700 - 100r and the LM curve is given by Y = 500 + 100r, then equilibrium income and interest rate are given by:

50 and the interest rate falls by 0.5 percent

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.

movement along the; shift in the

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.

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

If the long-run aggregate supply curve is vertical, then changes in aggregate demand affect:

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?

production

(Exhibit: Keynesian Cross) In this graph, if firms are producing at level Y3, then inventories will ______, inducing firms to ______ production.

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

(Exhibit: Market for Real Money Balances) Based on the graph, if the interest rate is r3, then people will ______ bonds and the interest rate will ______.

sell; rise

Monetary neutrality is a characteristic of the aggregate demand-aggregate supply model in:

the long run but not in the short run

During the financial crisis of 2008-2009, many financial institutions stopped making loans even to creditworthy customers, which could be represented int he IS-LM model as a(n):

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

(Exhibit: Policy Interaction) Based on the graph, starting from equilibrium at interest rate r3, income Y2, IS1, and LM1, if there is an increase in government spending that shifts the IS curve to IS2, then in order to keep the interest rate constant, the Federal Reserve should _____ the money supply shifting to _____.

increase; LM2

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.

increase; increase

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

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

(Exhibit: Shift in Aggregate Demand) In this graph, initially the economy is at point E, with price P0 and output Y. Aggregate demand is given by curve AD0, 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 AD1. The economy moves first to point ______ and then, in the long run, to point ______.

C; B

(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.

E; A

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 point over a year, Okun's law predicts that real GDP would:

decrease by 1 percent

According to the Keynesian-cross analysis, if MPC stands for marginal propensity to consume, then a rise in taxes of change in T will:

decrease equilibrium income by change in T (MPC)/ (1- MPC).

In the IS-LM model, which two variables are influenced by the interest rate?

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

If taxes are raised, but the Fed prevents income from falling by raising the money supply, then:

investment rises by consumption falls

According to the theory of liquidity preference, the supply of real money balances:

is fixed by the central bank

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

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 __________.

$1 billion; more than $1 billion

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:

600

Changes in fiscal policy shift the:

IS curve

An increase in consumer saving for any given level of income will shift the

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:

between zero and one

Short-run fluctuations in output and employment are called:

business cycles

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 lowering the interest rate so that investment spending increases

An IS curve shows combinations of:

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

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 not affected by the interest rate, whereas in the IS-LM model fiscal expansion raises the interest rate and crowds out incestment

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

The IS curve plots the relationship between the interest rate and __________ that arises in the market for ______________.

national income; goods and services

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

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

The IS-LM model take _________ as exogenous.

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 less than