Econ 102: Chapter 12

The Pigou effect:

suggests that as prices fall and real money balances rise, consumers should feel wealthier and spend more.

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.

Possible explanations put forth for the Great Depression do not include:

the Pigou effect.

(Exhibit: IS-LM to Aggregate Demand) Based on the graph, if LM3 shifts to LM2 because the money supply decreases from M3 to M2 then, holding other factors constant:

the aggregate demand curve will shift to the left.

The slope of the IS curve depends on:

the interest sensitivity of investment and the marginal propensity to consume.

An economic change that does not shift the aggregate demand curve is a change in:

the price level.

In the IS-LM model, a decrease in the interest rate would be the result of a(n):

increase in the money supply.

According to the macroeconometric model developed by Data Resources Incorporated, if taxes are increased by $100 billion, but the money supply is held constant, then GDP will fall by about:

$25 billion.

If expected inflation equals 3 percent and monetary policymakers push the nominal interest rate to 1 percent, the real interest rate equals ______ percent.

-2

If the demand function for money is M/P = 0.5Y - 100r, then the slope of the LM curve is:

.0.005

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

50 and the interest rate falls by 0.5 percent.

(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: Short Run to Long Run) Based on the graph, if the economy starts from a short-term equilibrium at D, then the long-run equilibrium will be at ____ with a _____ price level.

C; higher

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

IS curve downward and to the left.

In the IS-LM model, starting with no expected inflation, if expected inflation becomes negative, then the:

IS curve shifts leftward.

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

One policy response to the U.S. economic slowdown of 2001 was tax cuts. This policy response can be represented in the IS-LM model by shifting the ______ curve to the ______.

IS; right

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

IS; shifts to the right

If investment does not depend on the interest rate, then the ______ curve is ______.

IS; vertical

Analysis of the short and long runs indicates that the ______ assumptions are most appropriate in ______.

Keynesian; the short run, whereas the classical assumptions are most appropriate in the long run.

An increase in the money supply shifts the ______ curve to the right, and the aggregate demand curve ______.

LM: shifts to the right

A decrease in the price level shifts the ______ curve to the right, and the aggregate demand curve ______.

LM; does not shift

If money demand does not depend on income, then the ______ curve is ______.

LM; horizontal

If money demand is extremely sensitive to the interest rate, then the ______ curve is ______.

LM; horizontal

One policy response to the U.S. economic slowdown of 2001 was to increase money growth. This policy response can be represented in the IS-LM model by shifting the ______ curve to the ______.

LM; right

(Exhibit: IS-LM to Aggregate Demand) Based on the graph, which is the correct ordering of the price levels and money supplies?

P1 >P2 andM1 <M2

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:

Y = 1,100, r = 6 percent.

If consumption is given by C = 200 + 0.75(Y - T) and investment is given by I = 200 - 25r, then the formula for the IS curve is:

Y = 1,600 - 3T - 100r + 4G.

In the IS-LM model, changes in taxes initially affect planned expenditures through: a. consumption b. investment c. government spending d. the interest rate

a. consumption

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. a. decrease; decrease; decrease; decrease b. increase; increase; increase; increase c. decrease; decrease; increase; increase d. increase; increase; decrease; decrease

a. decrease; decrease; decrease; decrease

According to the IS-LM model, if Congress raises taxes but the Fed wants to hold income constant, then the Fed must______ the money supply. a. increase b. decrease c. first increase and then decrease d. first decrease and then increase

a. increase

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

a. investment is not affected by the interest rate whereas in the IS-LM model fiscal expansion raises the interest rate and crowds out investment.

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

a. less than

If Congress passed a tax increase at the request of the president to reduce the budget deficit, but the Fed held the money supply constant, then the two policies together would generally lead to ______ income and a ______ interest rate. a. lower, lower b. lower, higher c. no change in, lower d. no change in, higher

a. lower; lower

(Exhibit: IS-LM Monetary Policy) Based on the graph, starting from equilibrium at interest rate r1 and income Y1, a decrease in the money supply would generate the new equilibrium combination of interest rate and income: a. r2, Y2 b. r3, Y2 c. r2, Y3 d. r3, Y3

a. r2, Y2

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 ______. a. rises, falls b. rises, rises c. falls, rises d. falls, falls

a. rises; falls

If the government wants to raise investment but keep output constant, it should:

adopt a loose monetary policy and a tight fiscal policy.

If the money supply increases, then in the IS-LM analysis the ______ curve shifts to the ______. a. LM, left b. LM, right c. IS, left d. IS, right

b. LM; right

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

b. by lowering the interest rate so that investment spending increases.

According to the IS-LM model, if Congress raises taxes but the Fed wants to hold the interest rate constant, then the a. increase b. decrease c. first increase and then decrease d. first decrease and then increase

b. decrease

In the IS-LM model, the impact of an increase in government purchases in the goods market has ramifications in the money market, because the increase in income causes a(n) ______ in money ______. a. increase, supply b. increase, demand c. decrease, supply d. decrease, demand

b. increase; demand

The monetary transmission mechanism works through the effects of changes in the money supply on: a. budget deficit b. investment c. government expenditures d. taxation

b. investment

(Exhibit: IS-LM Fiscal Policy) Based on the graph, starting from equilibrium at interest rate r1 and income Y1, a decrease in government spending would generate the new equilibrium combination of interest rate and income: a. r2, Y2 b. r3, Y2 c. r2, Y3 d. r3, Y3

b. r3, Y2

In the IS-LM model when government spending rises, in short-run equilibrium, in the usual case the interest rate ______ and output ______. a. rises, falls b. rises, rises c. falls, rises d. falls, falls

b. rises; rises

If real money balances enter the IS-LM model both through the theory of liquidity preference and the Pigou effect, then a fall in the price level will shift:

both the LM and the IS curves.

When bond traders for the Federal Reserve seek to decrease interest rates, they ______ bonds, which shifts the ______ curve to the right.

buy; LM

If MPC = 0.75 (and there are no income taxes but only lump-sum taxes) when T decreases by 100, then the IS curve for any given interest rate shifts to the right by: a. 100 b. 200 c. 300 d. 400

c. 300

In the IS-LM model when M rises but P remains constant, in short-run equilibrium, in the usual case the interest rate ______ and output ______. a. rises, falls b. rises, rises c. falls, rises d. falls, falls

c. falls; rises

In the IS-LM model when M/P rises, in short-run equilibrium, in the usual case the interest rate ______ and output .______ a. rises, falls b. rises, rises c. falls, rises d. falls, falls

c. falls; rises

The increase in income in response to a fiscal expansion in the IS-LM is: a. always less than in the Keynesian-cross model b. less than in the Keynesian-cross model unless the LM curve is vertical c. less than in the Keynesian-cross model unless the LM curve is horizontal d. less than in the Keynesian-cross model unless the IS curve is vertical

c. less than in the Keynesian-cross model unless the LM curve is horizontal.

(Exhibit: IS-LM Fiscal Policy) Based on the graph, starting from equilibrium at interest rate r1 and income Y1, a tax cut would generate the new equilibrium combination of interest rate and income: a. r2, Y2 b. r3, Y2 c. r2, Y3 d. r3, Y3

c. r2, Y3

(Exhibit: IS-LM Fiscal Policy) Based on the graph, starting from equilibrium at interest rate r1 and income Y1, an increase in government spending would generate the new equilibrium combination of interest rate and income: a. r2, Y2 b. r3, Y2 c. r2, Y3 d. r3, Y3

c. r2, Y3

In the IS-LM model when the Federal Reserve decreases the money supply, people ______ bonds and the interest rate ______, leading to a(n) ______ in investment and income. a. buy, rises, increase b. sell, falls, decrease c. sell, rises, decrease d. buy, rises, decrease

c. sell; rises; decrease

Using the IS-LM analysis, if the LM curve is not horizontal, the multiplier for an increase in government spending is ______ for an increase in government purchases using the Keynesian-cross analysis. a. larger than the multiplier b. the same as the multiplier c. smaller than the multiplier d. sometimes larger and sometimes smaller than the multiplier

c. smaller than the multiplier

The Pigou effect suggests that falling prices will increase income because real balances influence ______ and will shift the ______ curve.

consumer spending; IS

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

If MPC = 0.75 (and there are no income taxes) when G increases by 100, then the IS curve for any given interest rate shifts to the right by: a. 100 b. 200 c. 300 d. 400

d. 400

In the IS-LM model when taxation increases, in short-run equilibrium, the interest rate ______ and output ______. a. rises, falls b. rises, rises c. falls, rises d. falls, falls

d. falls; falls

In the IS-LM model under the usual conditions in a closed economy, an increase in government spending increases the interest rate and crowds out: a. prices b. investment c. the money supply d. taxes

d. investment

If the demand for real money balances does not depend on the interest rate, then the LM curve: a. slopes up to the right b. slopes down to the right c. is horizontal d. is vertical

d. is vertical.

(Exhibit: IS-LM Monetary Policy) 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: a. r2, Y2 b. r3, Y2 c. r2, Y3 d. r3, Y3

d. r3, Y3

The interaction of the IS curve and the LM curve together determine: a. the price level and the inflation rate b. the interest rate and the price level c. investment and the money supply d. the interest rate and the level of output.

d. the interest rate and the level of output.

If the LM curve is vertical and government spending rises by G, in the IS-LM analysis, then equilibrium income rises by: a. G/(1-MPC) b. more than zero but less than G/(1-MPC) c. G d. zero

d. zero

An unexpected deflation can change demand by redistributing wealth from:

debtors to creditors, thus lowering consumption.

In the IS-LM model, a decrease in expected inflation (or an increase in expected deflation), leads to a(n):

decrease in both output and the nominal interest rate.

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; LM

(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 output constant, the Federal Reserve should _____ the money supply shifting to _____.

decrease; LM3

If real money balances enter the IS-LM model both through the theory of liquidity preference and the Pigou effect, then a fall in the price level will result in higher income and:

either higher, lower, or unchanging interest rates.

Other things equal, a given change in money supply has a larger effect on demand the:

flatter the IS curve.

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

flatter the LM curve.

The debt-deflation hypothesis explains the fall in income as a consequence of unexpected deflation transferring wealth ______, and that creditors have ______ propensity to consume than debtors.

from debtors to creditors; a smaller

All of the following may have contributed to the financial crisis and economic downturn of 2008-2009 except:

high inflation.

If investment demand is infinite below some certain r (e.g., r**) and zero above r**, then the IS curve is ______ and ______ policy has no effect on output.

horizontal; fiscal

If money demand is infinite below some certain r (e.g., r*) and zero above r*, then the LM curve is ______ and ______ policy has no effect on output.

horizontal; monetary

An increase in taxes lowers income:

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

An increase in government spending raises income:

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

Most economists believe:

in view of what economists now know about monetary and fiscal policy, and in view of institutional changes, a repeat of the Great Depression is unlikely.

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.

In the IS-LM model, a decrease in output would be the result of a(n):

increase in money demand.

(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

An increase in investment demand for any given level of income and interest rates—due, for example, to more optimistic "animal spirits"—will, within the IS-LM framework, ______ output and ______ interest rates.

increase; raise

A liquidity trap occurs when:

interest rates fall so low that monetary policy is no longer effective.

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

investment rises but consumption falls.

If the investment demand function is I = c - dr and the quantity of real money demanded is eY - fr, then monetary policy is relatively potent in influencing aggregate demand when d is ______ and f is ______.

large; small.

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

larger the marginal propensity to consume.

The spending hypothesis suggests that the Great Depression was caused by a:

leftward shift in the IS curve.

The money hypothesis suggests that the Great Depression was caused by a:

leftward shift in the LM curve.

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

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.

One explanation for the impact of expected price changes on the level of output is that an increase in expected deflation ______ the nominal interest rate and ______ the real interest rate, so that investment spending declines.

lowers; raises

If a liquidity trap does exist, then ______ policy will not be effective in increasing income when interest rates reach very ______ levels.

monetary; low

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

steeper the IS curve.

According to the macroeconometric model developed by Data Resources Incorporated, the response of GDP four quarters after an increase in government spending, with the nominal interest rate held constant, will be ______ the response of GDP to a similar change with the money supply held constant.

more than three times as great as

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

Starting from a short-run equilibrium greater than the natural rate of output, as the economy returns to a long-run equilibrium:

output will decrease, but the price level will increase.

If the short-run IS-LM equilibrium occurs at a level of income above the natural level of output, in the long run the ______ will ______ in order to return output to the natural level.

price level; increase

The macroeconomic model may be completed by adding either the Keynesian assumption that ______ or the classical assumption that ______.

prices are fixed; output is fixed

The Great Depression in the United States:

probably cannot be considered to have started because of a leftward shift in the LM curve because real balances did not fall between 1929 and 1931.

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

r2, 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.

Investment depends on the ______ interest rate, and money demand depends on the ______ interest rate.

real; nominal

A change in income in the IS-LM model for a fixed price

represents a shift in the aggregate demand curve.

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

responsiveness of investment to the interest rate is small.

Those 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.

A movement along an aggregate demand curve corresponds to a change in income in the IS-LM model ______, while a shift in an aggregate demand curve corresponds to a change in income in the IS-LM model ______.

resulting from a change in the price level; at a given price level

If the demand function for money is M/P = 0.5Y - 100r and if M/P increases by 100, then the LM curve for any given interest rate shifts to the:

right by 200.

A tax cut combined with tight money, as was the case in the United States in the early 1980s, should lead to a:

rise in the real interest rate and a fall in investment.

When bond traders for the Federal Reserve seek to increase interest rates, they ______ bonds, which shifts the ______ curve to the left.

sell; LM

If the investment demand function is I = c - dr and the quantity of real money demanded is eY - fr, then fiscal policy is relatively potent in influencing aggregate demand when d is ______ and f is ______.

small; large

Other things equal, a given change in money supply has a larger effect on demand the:

smaller the income sensitivity of money demand.

When drawn with the interest rate on the vertical axis and income on the horizontal axis, the IS curve will be steeper the:

smaller the sensitivity of investment spending to the interest rate.

The LM curve is steeper the ______ the interest sensitivity of money demand and the ______ the effect of income on money demand.

smaller; greater

(Exhibit: IS-LM to Aggregate Demand) Based on the graph, if LM1 shifts to LM2 because the price level decreases from P1 to P2 then, holding other factors constant:

this represents a movement down the aggregate demand curve.

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

If money demand does not depend on the interest rate, then the LM curve is ______ and ______ policy has no effect on output.

vertical; fiscal

If neither investment nor consumption depends on the interest rate, then the IS curve is ______ and ______ policy has no effect on output.

vertical; monetary