5.3 Putting the IS and the LM Relations Together

D) none of the above

We know with certainty that a tax increase must cause which of the following? A) an increase in investment B) a reduction in investment C) no change in investment D) none of the above

A) a rightward shift in the IS curve

An increase in government spending will likely have which of the following effects? A) a rightward shift in the IS curve B) a leftward shift in the IS curve C) an upward shift in the LM curve D) a downward shift in the LM curve

C) an upward shift in the LM curve

An increase in the aggregate price level, P, will most likely have which of the following effects? A) a rightward shift in the IS curve B) a leftward shift in the IS curve C) an upward shift in the LM curve D) a downward shift in the LM curve

D) a downward shift in the LM curve

A Fed purchase of securities will most likely have which of the following effects? A) a rightward shift in the IS curve B) a leftward shift in the IS curve C) an upward shift in the LM curve D) a downward shift in the LM curve

C) a reduction in the interest rate and an ambiguous effect on investment

A fiscal contraction will tend to cause which of the following to occur? A) a reduction in the interest rate and a reduction in investment B) a reduction in the interest rate and an upward shift in the LM curve C) a reduction in the interest rate and an ambiguous effect on investment D) no change in output if the Fed simultaneously pursues contractionary monetary policy

Answer: The fiscal expansion will cause an increase in output. However, changes in Y only cause movements along the LM curve. The effects of changes in Y on the interest rate are embedded in the shape of the LM curve.

A fiscal expansion (e.g. a tax cut) will result in an increase in income, an increase in money demand, and an increase in the equilibrium interest rate in financial markets. Explain what happens to the position of the LM curve as policy makers pursue expansionary fiscal policy.

B) a leftward shift in the IS curve

A reduction in consumer confidence will likely have which of the following effects? A) a rightward shift in the IS curve B) a leftward shift in the IS curve C) an upward shift in the LM curve D) a downward shift in the LM curve

D) a downward shift in the LM curve

A reduction in the aggregate price level, P, will most likely have which of the following effects? A) a rightward shift in the IS curve B) a leftward shift in the IS curve C) an upward shift in the LM curve D) a downward shift in the LM curve

D) a downward shift in the LM curve

A reduction in the reserve deposit ratio, θ, will most likely have which of the following effects? A) a rightward shift in the IS curve B) a leftward shift in the IS curve C) an upward shift in the LM curve D) a downward shift in the LM curve

An increase in consumer confidence will tend to cause which of the following to occur? A) a rightward shift in the IS curve B) a leftward shift in the IS curve C) an upward shift in the LM curve D) a downward shift in the LM curve

A) a rightward shift in the IS curve

E) no change in output if investment is independent of the interest rate

An increase in the money supply must cause which of the following? A) a leftward shift in the IS curve B) a reduction in the interest rate and ambiguous effects on investment C) an increase in investment and a rightward shift in the IS curve D) no change in the interest rate if investment is independent of the interest rate E) no change in output if investment is independent of the interest rate

D) all of the above

An increase in the money supply will cause an increase in which of the following variables? A) output B) investment C) consumption D) all of the above E) none of the above

C) an upward shift in the LM curve

An increase in the reserve deposit ratio, θ, will most likely have which of the following effects? A) a rightward shift in the IS curve B) a leftward shift in the IS curve C) an upward shift in the LM curve D) a downward shift in the LM curve

E) none of the above

Assume that investment does not depend on the interest rate. A reduction in government spending will cause which of the following for this economy? A) no change in the interest rate B) no change in output C) no change in investment D) an increase in investment E) none of the above

B) no change in output

Assume that investment does not depend on the interest rate. A reduction in the money supply will cause which of the following for this economy? A) no change in the interest rate B) no change in output C) a reduction in investment D) an increase in investment

C) a gradual reduction in i and gradual reduction in Y.

Based on our understanding of the IS-LM model that takes into account dynamics, we know that a reduction in government spending will cause A) an immediate drop in Y and immediate increase in i. B) an immediate reduction in i and no initial change in Y. C) a gradual reduction in i and gradual reduction in Y. D) a gradual reduction in i and an immediate reduction in Y.

B) an immediate increase in i and no initial change in Y.

Based on our understanding of the IS-LM model that takes into account dynamics, we know that a reduction in the money supply will cause A) an immediate drop in Y and immediate increase in i. B) an immediate increase in i and no initial change in Y. C) a gradual increase in i and gradual reduction in Y. D) none of the above

A) a gradual increase in i and gradual increase in Y.

Based on our understanding of the IS-LM model that takes into account dynamics, we know that an increase in government spending will cause A) a gradual increase in i and gradual increase in Y. B) an immediate increase in Y and immediate drop in i. C) an immediate increase in i and no initial change in Y. D) a gradual increase in i and an immediate increase in Y.

B) an immediate decrease in i and no initial change in Y.

Based on our understanding of the IS-LM model that takes into account dynamics, we know that an increase in the money supply will cause A) an immediate increase in i and no initial change in Y. B) an immediate decrease in i and no initial change in Y. C) a gradual decrease in i and gradual increase in Y. D) none of the above

Answer: An increase in M will cause the LM curve to shift down and the interest rate to fall. As the interest rate falls, firms will increase investment causing an increase in demand and subsequent increase in output. So, the interest rate will fall and Y will rise. I will be higher due to the rise in Y and drop in the interest rate.

Based on your understanding of the IS-LM model, graphically illustrate and explain what effect a monetary expansion will have on output, the interest rate, and investment.

Answer: A reduction in consumer confidence will cause a reduction in consumption and, therefore, a reduction in demand and a leftward shift in the IS curve. As Y decreases, money demand will decrease causing the interest rate to fall. The effects on I are ambiguous. The lower Y will cause I to fall while the lower interest rate will cause I to increase.

Based on your understanding of the IS-LM model, graphically illustrate and explain what effect a reduction in consumer confidence will have on output, the interest rate, and investment.

Answer: A Fed purchase of bonds will cause an increase in H and an increase in the money supply. This will cause an excess supply of money and the interest rate must decline to restore money market equilibrium. The LM curve will shift down as a result of this to reflect the now lower interest rate. The IS curve does not shift as a result of this. We would simply observe a movement along the IS curve.

Explain in detail what effect a Fed purchase of bonds will have on: (1) the LM curve; and (2) the IS curve.

Answer: A Fed sale of bonds will cause a reduction in H and a reduction in the money supply. This will cause an excess demand for money and the interest rate must increase to restore money market equilibrium. The LM curve will shift up as a result of this to reflect the now higher interest rate. The IS curve does not shift as a result of this. We would simply observe a movement along the IS curve.

Explain in detail what effect a Fed sale of bonds will have on: (1) the LM curve; and (2) the IS curve.

Answer: A reduction in taxes will cause an increase in disposable income and an increase in consumption. The rise in C will cause an increase in demand and the equilibrium level of output in the goods market will be higher. This is reflected in a rightward shift in the IS curve. Goods market events such as this will not cause a shift in the LM curve (only a movement along it).

Explain in detail what effect a reduction in government spending will have on: (1) the LM curve; and (2) the IS curve.

Answer: An increase in government spending will cause an increase in demand and the equilibrium level of output in the goods market will be higher. This is reflected in a rightward shift in the IS curve. Goods market events such as this will not cause a shift in the LM curve (only a movement along it).

Explain in detail what effect an increase in government spending will have on: (1) the LM curve; and (2) the IS curve.

C) will cause a reduction in the interest rate.

For this question, assume that investment spending depends only on output and no longer depends on the interest rate. Given this information, an increase in the money supply A) will cause investment to decrease. B) will cause investment to increase. C) will cause a reduction in the interest rate. D) will have no effect on output or the interest rate. E) will cause an increase in output and have no effect on the interest rate.

B) the IS curve shift leftward.

If government spending and taxes decrease by the same amount, A) the IS curve does not shift. B) the IS curve shift leftward. C) the IS curve shifts rightward. D) the LM curve shifts downward.

C) the IS curve shifts rightward

If government spending and taxes increase by the same amount, A) the IS curve does not shift B) the IS curve shift leftward C) the IS curve shifts rightward D) the LM curve shifts downward

Answer: A policy that causes a reduction in the budget deficit will have an ambiguous effect on investment. Output will fall which will tend to depress I. However, the interest rate will also fall which will tend to increase I. I could increase, decrease, or remain unchanged

Increases in the budget deficit are believed to cause reductions in investment. Based on your understanding of the IS-LM model, will a fiscal policy action that causes a reduction in the budget deficit cause an increase in investment? Explain.

E) all of the above

Suppose the current level of output and the interest rate are such that the economy is operating on neither the IS nor LM curve. Which of the following is true for this economy? A) Production does not equal demand. B) The money supply does not equal money demand. C) The quantity supplied of bonds does not equal the quantity demanded of bonds. D) Financial markets are not in equilibrium. E) all of the above

E) all of the above

Suppose the economy is currently operating on both the LM curve and the IS curve. Which of the following is true for this economy? A) Production equals demand. B) The quantity supplied of bonds equals the quantity demanded of bonds. C) The money supply equals money demand. D) Financial markets are in equilibrium. E) all of the above

B) the money market and bond markets are in equilibrium and the goods market is not in equilibrium.

Suppose the economy is operating on the LM curve but not on the IS curve. Given this information, we know that A) the goods market is in equilibrium and the money market is not in equilibrium. B) the money market and bond markets are in equilibrium and the goods market is not in equilibrium. C) the money market and goods market are in equilibrium and the bond market is not in equilibrium. D) the money, bond and goods markets are all in equilibrium. E) neither the money, bond, nor goods markets are in equilibrium.

C) consumption and output

Suppose there is a fiscal contraction. Which of the following is a complete list of the variables that must decrease? A) consumption B) consumption and investment C) consumption and output D) consumption, output and the interest rate E) consumption, output and investment

E) consumption, output and the interest rate

Suppose there is an increase in consumer confidence. Which of the following represents the complete list of variables that must increase in response to this increase in consumer confidence? A) consumption B) consumption and investment C) consumption, investment and output D) consumption and output E) consumption, output and the interest rate

B) a reduction in the interest rate

The IS curve will not shift when which of the following occurs? A) a reduction in government spending B) a reduction in the interest rate C) a reduction in consumer confidence D) all of the above E) none of the above

B) a reduction in government spending

The IS curve will shift to the left when which of the following occurs? A) a reduction in the money supply B) a reduction in government spending C) an increase in the interest rate D) all of the above E) none of the above

Answer: Changes in the interest rate do cause changes in investment, demand, and output. However, they do not cause shifts of the IS curve. Changes in the interest rate cause movements along the IS curve.

When the central bank pursues contractionary monetary policy, we that this policy will result in an increase in the interest rate, a reduction in investment, a reduction in demand, and a lower level of equilibrium output. Explain what happens to the position of the IS curve as the central bank pursues contractionary monetary policy.

A) the combinations of i and Y that maintain equilibrium in the goods market

Which of the following best defines the IS curve? A) the combinations of i and Y that maintain equilibrium in the goods market B) illustrates the effects of changes in i on investment C) illustrates the effects of changes in i on desired money holdings by individuals D) the combinations of i and Y that maintain equilibrium in financial markets

D) the combinations of i and Y that maintain equilibrium in financial markets

Which of the following best defines the LM curve? A) the combinations of i and Y that maintain equilibrium in the goods market B) illustrates the effects of changes in i on investment C) illustrates the effects of changes in i on desired money holdings by individuals D) the combinations of i and Y that maintain equilibrium in financial markets

A) A reduction in the interest rate causes investment spending to decrease.

Which of the following occurs as the economy moves rightward along a given IS curve? A) A reduction in the interest rate causes investment spending to decrease. B) A reduction in the interest rate causes money demand to increase. C) A reduction in the interest rate causes a reduction in the money supply. D) An increase in government spending causes a reduction in demand for goods. E) A reduction in taxes causes a reduction in demand for goods.

A) decline in investment demand

Which of the following triggered the U.S. recession of 2001? A) decline in investment demand B) decline in consumption demand C) increase in budget deficit D) increase in trade deficit