Macrotheory Chapter 13

Based on the graph, starting from equilibrium at interest rate r1 and income Y1, an increase in the money supply would generate the new equilibrium combination of interest rate and income:

r3, Y3.

Other things equal, an expected deflation can change demand by:

raising the real interest rate for any given nominal interest rate, thus reducing desired investment.

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

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

IS; shifts to the right

If investment does not depend on the interest rate, the IS curve is vertical.

True

If money demand does not depend on income, the LM curve is horizontal.

True

If money demand does not depend on the interest rate, the LM curve is vertical.

True

If money demand is extremely sensitive to the interest rate, the LM curve is horizontal.

True

In the IS-LM model, which of the following causes income to decline and the interest rate to rise?

a decrease in the money supply

Other things equal, a given change in government spending has a larger effect on demand the:

flatter the LM curve.

An increase in taxes lowers income:

in the short run but leaves it unchanged in the long run, while lowering consumption and increasing investment.

Suppose that a heightened risk of terrorist attack reduces consumer confidence, inducing people to save more. To stabilize aggregate demand, the Fed should:

increase the money supply to lower the interest rate.

An increase in the demand for money, at any given income level and level of interest rates, will, within the IS-LM framework, _____ output and _____ interest rates.

lower; raise

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

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:

50 and the interest rate falls by 0.5 percent.

If MPC = 0.6 (and there are no income taxes) when G increases by 200, then the IS curve for any given interest rate shifts to the right by:

500

If investment does not depend on the interest rate, the LM curve is horizontal.

False

If money demand does not depend on the interest rate, the IS curve is horizontal.

False

Based on the graph, which is the correct ordering of the price levels and money supplies?

P1 > P2 and M1 < M2

In the IS-LM model, which of the following causes both the interest rate and income to decline?

an increase in taxes

The severity of the Great Depression may be partly explained by an increase in expected

deflation, which raised real interest rates above nominal interest rates.

Assume the Fed holds the interest rate constant in response to an increase in government purchases. Use this information to answer the following question. The money supply will ____ and the impact on income will be ____ than if the money supply were held constant.

increase, larger

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

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 investment.

A given increase in taxes shifts the IS curve more to the left the:

larger the marginal propensity to consume.

Again, suppose the government wants to change the level of output. If the IS curve is vertical, then

monetary policy is completely ineffective, whereas fiscal policy is highly effective.

Suppose the government wants to change the level of output. If the LM curve is horizontal, then

monetary policy is ineffective, whereas fiscal policy is highly effective.

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 and the Federal Reserve does not change the money supply, the new equilibrium combination of interest and income will be:

r2, Y3.

Economists who believe that monetary policy is more potent than fiscal policy argue that the:

responsiveness of money demand to the interest rate is small.

If output is above its natural level, over time the price level will ____ shifting the ___ curve and moving the economy toward its long‐run equilibrium.

rise, LM

If an economy is in a liquidity trap, then an expansionary monetary policy ends up increasing:

the liquidity of household portfolio.

The debt-deflation theory of the Great Depression suggests that an _____ deflation redistributes wealth in such a way as to _____ spending on goods and services.

unexpected; reduce