Mac Midterm 2

If Fed A cares only about keeping the price level stable and Fed B cares only about keeping output at its natural level, then in response to an exogenous increase in the price of oil:

Fed A should decrease the quantity of money stable whereas Fed B should increase it.

Effective monetary policy:

Flat(elastic) IS, shift LM R; Steep(inelastic) LM, Shift LM R

In the aggregate demand/aggregate supply model, long-run equilibrium occurs at the combination of output and prices where:

aggregate demand equals short-run and long-run aggregate supply.

The ISand LMcurves together generally determine:

both income and the interest rate.

The monetary transmission mechanism in the IS-LMmodel is a process whereby an increase in the money supply increases the demand for goods and services:

by lowering the interest rate so that investment spending increases.

Monetary policy is more effective when investment demand is relatively ____

elastic

If money demand is extremely sensitive to change in interest rates, then the _____ is more effective

fiscal policy

According to the theory of liquidity preference, holding the supply of real money balances constant, an increase in income will ______ the demand for real money balances and will ______ the interest rate.

increase; increase

Starting from long-run equilibrium (assuming the upward-sloping SRAS), if a drought pushes up food prices throughout the economy, the Fed could move the economy more rapidly back to full employment output by:

increasing the money supply, but at the cost of permanently higher prices.

A liquidity trap occurs when:

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

The increase in equilibrium outputin response to a fiscal expansion in the IS-LMmodel is:

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

If the short-run aggregate supply curve is horizontal, then changes in aggregate demand affect:

level of output but not prices.

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.

lower; lower

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

money supply

The aggregate demand curve is the ______ relationship between the quantity of output demanded and the ______.

negative; price level

If the short-run aggregate supply curve is horizontal and the Fed increases the money supply, then:

output and employment will increase in the short run.

Assume that the economy begins in long-run equilibrium and the SRAS is upward- sloping curve. Then the Fed reduces the money supply. In the short run ______, whereas in the long run prices ______ and output returns to its original level.

output and prices both decrease; fall

When the interest elasticity of money demand is low,

the LM curve is steep

If money demand is extremely responsive to the interest rate, then:

the fiscal policy is effective.

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

LM; does not shift

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

LM; vertical

A decrease in the price level, holding nominal money supply constant, will shift the LMcurve:

downward and to the right.

In the aggregate demand-aggregate supply model, short-run equilibrium occurs at the combination of output and prices where:

aggregate demand equals short-run aggregate supply.

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

When slope of b is extremely small

IS: steep Fiscal policy is ineffective

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

IS; right

Policy mix with the largest effect

Increase G, Increase Ms

Income in expansionary fiscal is less in IS-LM than in Keynesian:

Investment is not effected by r, in IS-LM expansion raises interest and crowds out investment

When the Federal Reserve reduces the money supply, at a given price level the amount of output demanded is ______ and the aggregate demand curve shifts ______.

Lower; to the left

Effective fiscal policy:

Steep(inelastic)IS, shift IS R; Flat(elastic) LM, shift IS R

According to the IS-LMmodel, if Congress cutstaxes but the Fed wants to hold income constant, then the Fed must ______ the money supply.

decrease

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.

decrease; decrease; decrease; decrease

When an aggregate demand curve is drawn with real GDP (Y) along the horizontal axis and the price level (P) along the vertical axis, if the money supply is decreased, then the aggregate demand curve will shift:

downward and to the left.

According to the IS-LMmodel, 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-LMmodel, a decrease in the interest rate would be the result of a(n):

increase in the money supply.

A Keynesian short-run aggregate supply curve shows fixed ______, and a Classical long-run aggregate supply curve shows fixed ______.

prices; output

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

prices; output

In the IS-LMmodel when Mremains constant but Prises, in short-run equilibrium, in the usual case, the interest rate ______ and output ______.

rises; falls

In ISLM model the combination of expansionary fiscal and contractionary monetary policy....

usually cause interest rates to rise

In the standard IS-LM model, an expansionary fiscal policy and a contractionary monetary policy

usually causes interest rates to rise.

If investment demand does not depend on interest rate, the IS curve is____ and ____ policy has no effect on output

vertical, monetary

If the LMcurve is vertical and taxes cutby ∆T, in the IS-LManalysis, then equilibrium income rises by:

zero