Econ 308 Test 2

When planned expenditure is drawn on a graph as a function of income, the slope of the line is?

Between zero and one

In the Keynesian-cross model, actual expenditures equal

GDP

The following relationships describe the closed economy of Fredonia Y = C + I + G C = 69 + 0.8 (Y-T) I = 140 - 8r G = $55 billion T = $40 billion M = $1200 billion P = 3 Derive the IS equation (Y as a function of r)

Y = C + I + G Y = 69 + 0.8 (Y-40) + 140 - 8r + 55 Y = 1160 - 40r

The IS curve plots the relationship between interest rate and _____ that arises in the market for _______

national income; goods and services

In the Keynesian-cross model, if the MPC equals 0.75, then a $2 billion increase in government spending increases planned expenditures by ______ and increases the equilibrium level of income by _______

$2 billion; $8 billion Multiplier= 1/(1-MPC) Multiplier= 1/(1-0.75) Multiplier= 1/0.25 Multiplier is 4 Change in Income - 4 x 2 Billion

In the Keynesian-cross model, if the MPC equals 0.75, then a $3 billion decrease in taxes increases planned expenditures by _____ and increases the equilibrium level of income by _____

$2.25 billion; $9 billion Multiplier= 1/(1-MPC) Multiplier= 1/(1-0.75) Multiplier= 1/0.25 Multiplier is 4 New Consumption = 0.75 x 3 Billion = 2.25 Billion 2.25 Billion x 4 = 9 billion

Assume that the money demand function is (M/P)d = 2200 - 200r, where r is 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

(M/P)d = 2200 - 200(7) = 2200-1400 Md/2 = 800 Md = 800 x 2 = 1600 Md = Ms Money Supply = 1600

The following relationships describe the closed economy of Fredonia Y = C + I + G C = 69 + 0.8 (Y-T) I = 140 - 8r G = $55 billion T = $40 billion M = $1200 billion P = 3 MPd= Y - 10r Derive the LM equation (Y as a function of r)

(M/P)d = Y - 10r (1200/3) = Y - 10r 400 = Y - 10r Y = 400 + 10r

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 1000 is

AD = C + I + G = 200 + 0.7(1000 - 100) + 100 + G AD = 930 + G Equilibrium, Y = AD 1000 = 930 + G G = 70

In the Keynesian-cross analysis, if the consumption function is given by C = 200 + 0.7 (Y-T), and planned investment is 100, G is 100, and T is 100, then equilibrium Y is

Aggregate Demand = C + I + G = 200 + 0.7 (Y-100) + 100 + 100 = 400 + 0.7Y - 70 = 330 + 0.7Y Equilibrium, Y=AD Y = 330 + 0.7Y 0.3Y = 330 Y = 1100

In the Keynesian-cross model, fiscal policy has a multiplying effect on income because fiscal policy

Changes income, which changes consumption, which further changes income

When is the final exam?

December 9th, 10:30, Hewson 2008

When gross domestic product (GDP) growth declines, investment spending typically _____ and consumption spending typically _____

Decreases; decreases

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

Starting from long-run equilibrium, if the velocity of money increases (due to, for example, the invention of automatic teller machines), the Fed might be able to stabilize output by

Decreasing the money supply

For a fixed money supply, the aggregate demand curve slopes downward because at a lower price level, real money balances are _____, generating a ______ quantity of output demanded

Higher; greater

The dilemma facing the Federal Reserve in the event that an unfavorable supply shock moves the economy away from the natural rate of output is that monetary policy can either return output to the natural rate but with a _____ price level or allow the price level to return to its original level but with a _____ level of output in the short run

Higher; lower

According to the quantity theory of money, when velocity is constant, if output is higher, ______ real balances are required, and for fixed M this means ______ P

Higher;lower

The following relationships describe the closed economy of Fredonia Y = C + I + G C = 69 + 0.8 (Y-T) I = 140 - 8r G = $55 billion T = $40 billion M = $1200 billion P = 3 Solve for the equilibrium interest rate and output

IS = LM 1160 - 40r = 10r + 400 r = 15.2 Plug R into either IS or LM to find output Y = 1160 - 40(15.2) = 552 Y = 400 + 10(15.2) = 552

A 5 percent reduction in the money supply will, according to most economists, reduce prices 5 percent

In the long run but lead to unemployment in the short run

If a change in government regulations allows banks to start paying interest on checking accounts, this will

Increase the demand for money

In the Keynesian-cross model, if traces are reduced by 100, then planned expenditures ______ for any given level of income

Increase, but by less than 100

According to the theory of liquidity preference, decreasing the money supply will _____ nominal interest rates in the short run, and, according to the Fisher effect, decreasing the money supply will ____ nominal interest rates in the long run

Increase; decrease

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

Since the Covid-19 health crisis caused many businesses to temporarily shut down and lay off their workers, there was a(n) _____ in the natural rate of unemployment and the long-run aggregate supply (LRAS) curve shifted _____

Increase; left

Holding output, Y, fixed, a reduction in the demand for money is the equivalent of a(n) _____ in velocity and will shift the aggregate demand curve to the _____

Increase; right

The following relationships describe the closed economy of Fredonia Y = C + I + G C = 69 + 0.8 (Y-T) I = 140 - 8r G = $55 billion T = $40 billion M = $1200 billion P = 3 Illustrate the equilibrium interest rate and output on the IS-LM diagram

Label Y Axis as "r" Label X Axis as "y" Plot IS and LM Intersect at (output, r)

When firms experience unplanned inventory accumulation, they typically

Lay off workers and reduce production

Okun's law is the ____ relationship between real gross domestic product (GDP) and the _____

Negative; unemployment rate

The theory of liquidity preference states that the quantity of real money balances demanded is

Negatively related to the interest rate and positively related to income

Consider a closed economy to which the Keynesian-cross analysis applies. Consumption is given by the equation C = 200 + 2 / 3 (Y-T). Planned investment is 300, as are government spending and taxes If Y is 1500, what is planned spending? What is inventory accumulation of decumulation? Should equilibrium Y be higher or lower than 1500?

Planned spending = C + I + G = 200 + 2/3 (1500 - 300) + 300 + 300 = 1,600. Y is less than planned spending, inventory decumulation = 100 Equilibrium Y should be higher than 1,500

A short-run aggregate supply curve shows fixed _____, and a long run aggregate supply curve shows fixed

Prices; output

Monetary neutrality, the irrelevance of the money supply in determining values of ____ variables, is generally thought to be a property of the economy in the long run

Real

Draw an AD-AS diagram to show an economy in long-run equilibrium (denote potential GDP ). On your diagram, show the short-run effect of a one-time increase in oil prices. Describe the effects on output and the price level

See homework 7, #15 for solution

Draw an AD-AS diagram to show an economy in long-run equilibrium (denote potential GDP ). On your diagram, show the short-run effect of a one-time increase in oil prices. Redraw your diagram and show the transition back to the long run equilibrium under the economy's self-correcting mechanism. Describe how this transition takes place. What are the additional effects on output and the price level as the economy returns to a long-run equilibrium?

See homework 7, #15(a) for solution

Consider a closed economy to which the Keynesian-cross analysis applies. Consumption is given by the equation C = 200 + 2 / 3 (Y-T). Planned investment is 300, as are government spending and taxes What is equilibrium Y?

Y = C + I + G Y = 200 + 2/3 (Y - 300) + 300 + 300 Y = 1800

Draw an AD-AS diagram to show an economy in long-run equilibrium (denote potential GDP ). On your diagram, show the short-run effect of a one-time increase in oil prices. Redraw your diagram. Instead of the economy's self-correcting mechanism, prescribe an appropriate monetary policy to restore potential GDP in the short run, and show the policy effect on your diagram.

See homework 7, #15(b) for solution

Draw an AD-AS diagram to show an economy in long-run equilibrium (denote potential GDP ). On your diagram, show the short-run effect of a one-time increase in oil prices. Compare the long run price levels in parts b and c. Explain the difference (if any).

See homework 7, #15(c) for solution

If the interest rate is above the equilibrium value, the

Supply of real balances exceeds the demand

Two identical countries, Country A and Country B, can each be described by a Keynesian-cross model. The MPC is 0.7 in each country. Country A decides to increase spending by $2 billion, while Country B decides to cut taxes by $2 billion In which country will the new equilibrium level of income be greater?

Tax Multiplier = -MPC/1-Mpc Tax Multiplier = -2.33 Government Spending Multiplier = 1/(1-MPC) Government spending Multiplier = 3.33 Country A = 2 x 3.33 = 6.66 Country B = -2 x -2.33 = 4.66 Equilibrium will be greater in country A

Based on the Keynesian model, one reason to support government spending increases over tax cuts as measures to increase output is that

The government-spending multiplier is larger than the tax multiplier

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

The money supply

In the Keynesian-cross model, actual expenditures differ from planned expenditures by the amount of

Unplanned inventory investment

Consider a closed economy to which the Keynesian-cross analysis applies. Consumption is given by the equation C = 200 + 2 / 3 (Y-T). Planned investment is 300, as are government spending and taxes How much does equilibrium income decrease when G is reduced to 200? What is the multiplier for government spending?

Y = 200 + 2/3 (Y - 300) + 300 + 200 Y = 1500 Equilibrium Y decreases by 300. Multiplier = 1/(1-MPC) Multiplier - 3