Intermediate Macroeconomics Test #3

In explaining the 2003 bill to cut taxes, President Bush is quoted as saying, "When people have more money, they can spend it on goods and services." b. In the IS-LM model, does a tax cut shift the IS or the LM curve?

Shifts the IS curve to the right, leading to a new equilibrium

In the Keynesian cross model, assume that the consumption function is given by C= 120+0.8 (Y-T). Planned investment is 200; government purchases and taxes are both 400. e. Assuming that government purchases remain at 400, what level of taxes is needed to achieve an income of 2,400?

Taxes would have to increase to 300

Using the Keynesian-cross analysis, assume that the consumption function is given by C = 200 + 0.7 (Y - T). If the planned investment is 100 and T is 100, then the level of G needed to make equilibrium Y equal 1,000 is: a. 70. b. 120. c. 170. d. 220.

c. 170.

In explaining the 2003 bill to cut taxes, President Bush is quoted as saying, "When people have more money, they can spend it on goods and services." a. In the IS-LM model, will a tax cut change the money supply in the economy? Does a change in the money supply shift the IS or the LM curve?

- Tax cut = increases money supply; it leads to an increase in disposable income which people could ultimately spend on consumption. - The change in money supply leads to a shift in the IS curve. An increase in income and ultimately consumption will lead to a positive change in the goods market equilibrium

In explaining the 2003 bill to cut taxes, President Bush is quoted as saying, "When people have more money, they can spend it on goods and services." c. Based on your answers in a and b, how can you reconcile the president's statement with economics? Can you suggest how his statement could be modified to be consistent with the IS-LM model?

- The President's statement aligns with the economic effect of the tax cut but stating there would be an increase in government spending would have had a better effect. - Increases in government spending = more economic activity than a tax cut.

In the Keynesian cross model, assume that the consumption function is given by C= 120+0.8 (Y-T). Planned investment is 200; government purchases and taxes are both 400. b. What is equilibrium income?

2000

In the Keynesian cross model, assume that the consumption function is given by C= 120+0.8 (Y-T). Planned investment is 200; government purchases and taxes are both 400. c. If government purchases increase to 420, what is the new equilibrium income? What is the multiplier for government purchases?

Equilibrium income = 2100 The money multiplier is found with the MPC model. It = 5 1/ 1 - 0.8.

In the Keynesian cross model, assume that the consumption function is given by C= 120+0.8 (Y-T). Planned investment is 200; government purchases and taxes are both 400. d. Assuming that taxes remain at 400, what level of government purchases is needed to achieve an income of 2,400?

Government purchases would have to increase to 480.

Compare the predicted impact of an increase in the money supply in the liquidity preference model versus the impact predicted by the quantity theory and the Fisher effect. Can you reconcile this difference?

IS-LM Model: - Predicts an increase in money supply will decrease the interest rate - Emphasizes the short-run effect when prices are fixed, and Y is variable The Quantity Theory: - Predicts an increase in money supply will increase price level or inflation, which, via the Fisher effect, will increase the nominal interest rate. - Both the quantity theory and Fisher effect are long-run effects when prices are flexible and Y is fixed (at full employment level). The results are different because of the different underlying assumptions.

Macroland is a small open economy with perfect capital mobility and a flexible-exchange-rate system. Macroland is initially in equilibrium at the natural level of output with balanced trade. Compare the impact of a tax cut in the short run (when prices are fixed) and in the long run (when prices are flexible) on: (a) output, (b) consumption, (c) investment, (d) net exports, and (e) the exchange rate

a. In both the short run and long run, output is unchanged. b. Consumption is higher in both the short run and the long run because the tax cut increases disposable income. c. Investment is unchanged in the short run and the long run because there is no change in the world interest rate. d. In the short run and long run, net exports decrease by the amount that consumption increases because the exchange rate increases. Starting from balanced trade, the country will have a trade deficit in the short run and the long run. e. In the short run and long run, the exchange rate is higher because the tax cut puts upward pressure on the domestic interest rate, which attracts capital inflows and drives up the exchange rate.

A fall in consumer confidence about the future, which induces consumers to spend less and save more, will, according to the Mundell-Fleming model with fixed exchange rates, lead to: a. a fall in consumption and income. b. no change in consumption or income. c. no change in income but a rise in net exports. d. a fall in income but a rise in net exports.

a. a fall in consumption and income.

The debt-deflation hypothesis explains the fall in income as a consequence of unexpected deflation transferring wealth from____, and that creditors have a_____ propensity to consume than debtors. a. debtors to creditors; smaller b. debtors to creditors; larger c. creditors to debtors; smaller d. creditors to debtors; larger

a. debtors to creditors; smaller

According to the Mundell-Fleming model for a small open economy with flexible exchange rates, if the Federal Reserve cannot alter domestic interest rates, changes in the money supply could still influence aggregate income through changes in the: a. exchange rate. b. price level. c. level of government spending. d. tax rates.

a. exchange rate

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 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

If short-run equilibrium in the Mundell-Fleming model is represented by a graph with Y along the horizontal axis and the exchange rate along the vertical axis, then the IS* curve: a. slopes downward and to the right because the higher the exchange rate, the lower the level of net exports and, therefore, of short-run equilibrium income in the goods market. b. is vertical because there is only one investment level that is consistent with the world interest rate. c. is vertical because the exchange rate does not enter into the IS* equation. d. slopes downward and to the right because the higher the exchange rate, the higher the level of net exports and, therefore, of short-run equilibrium income in the goods market.

a. slopes downward and to the right because the higher the exchange rate, the lower the level of net exports and, therefore, of short-run equilibrium income in the goods market.

According to the Keynesian-cross analysis, if the marginal propensity to consume is 0.6 and government expenditures and autonomous taxes are both increased by 100, equilibrium income will rise by: a. 0. b. 100. c. 150. d. 250.

b. 100.

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): a. expansionary shift in the IS curve. b. contractionary shift in the IS curve c. expansionary shift in the LM curve d. contractionary shift in the LM curve

b. contractionary shift in the IS curve

In a small open economy with a floating exchange rate, if the government increases the money supply, then in the new short-run equilibrium, the: a. interest rate falls and the level of investment rises. b. exchange rate falls and net exports increase. c. interest rate falls but the level of investment does not rise. d. exchange rate falls but net exports do not increase.

b. exchange rate falls and net exports increase.

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

b. increase; decrease

In the Mundell-Fleming model with fixed exchange rates, attempts by the central bank to increase the money supply lead the exchange rate to fall, giving arbitrageurs the incentive to _____ the central bank, which causes the money supply to _____. a. sell domestic currency to; increase b. sell domestic currency to; decrease c. buy domestic currency from; increase d. buy domestic currency from; decrease

b. sell domestic currency to; decrease

Based on the Keynesian model, one reason to support government spending increases over tax cuts as measures to increase output is that: a. government spending increases the MPC more than tax cuts. b. the government-spending multiplier is larger than the tax multiplier. c. government-spending increases do not lead to unplanned changes in inventories, but tax cuts do. d. increases in government spending increase planned spending, but tax cuts reduce planned spending.

b. the government-spending multiplier is larger than the tax multiplier.

In the Mundell-Fleming model with a fixed exchange rate, a rise in the world interest rate will lead income: a. and net exports both to fall. b. to fall while net exports are unchanged. c. to be unchanged and net exports to fall. d. and net exports to both be unchanged.

b. to fall while net exports are unchanged.

The Pigou effect suggests that failing prices will increase income because real balances influence____and will shift the_____curve. a. money demand; LM b. the money supply; LM c. consumer spending; IS d. government spending; IS

c. consumer spending; IS

In a small open economy with a fixed exchange rate, if the country devalues its currency, then in the new short-run equilibrium the exchange rate _____, and the LM* curve shifts to the _____. a. decreases; left b. increases; left c. decreases; right d. increases; right

c. decreases; right

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

A liquidity trap occurs when a. banks have too much currency and close their doors to new customers b. the central bank mistakenly prints too much money, generating hyperinflation c. interest rates fall so low that monetary policy is no longer effective d. dams and locks are built to prevent flooding

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

The purchase of long-term government bonds, mortgage-backed securities and corporate debt with the intent of lowering interest rate on these kinds of loans is known as____, which is a part of_____. a. quantitative easing; unconventional monetary policy b. forward guidance; conventional monetary policy c. quantitative easing; loose fiscal policy d. forward guidance; tight fiscal policy

c. quantitative easing; loose fiscal policy

In the IS-LM model when the Federal Reserve decreases the money supply, the public ____ bonds, and the interest rate ____, leading to a(n) ____ in investment and income. This is called the monetary policy transmission mechanism. a. buy; rises; increase b. sells; falls; decrease c. sell; rises; decrease d. buy; rises; decrease

c. sell; rises; decrease

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: a. 350. b. 600. c. 950. d. 1,100.

d. 1,100.

Changes in fiscal policy shift the: a. LM curve. b. money demand curve. c. money supply curve. d. IS curve.

d. IS curve.