Exam 11: Aggregate Demand II: Applying the Is-Lm Model

Assume that the equilibrium in the money market may be described as M/P = 0.5Y - 100r, and M/P equals 800. a. Write the LM curve two ways, expressing Y as a function of r and r as a function of Y. (Hint: Write the LM curve only relating Y and r; substitute out M/P.) b. What is the slope of the LM curve? c. If r is 1 percent, what is Y along the LM curve? If r is 3 percent, what is Y along the LM curve? If r is 5 percent, what is Y along the LM curve? d. If M/P increases, does the LM curve shift upward and to the left or downward and to the right? e. If M increases and P is constant, does the LM curve shift upward and to the left or downward and to the right? f. If P increases and M is constant, does the LM curve shift upward and to the left or downward and to the right?

In the Keynesian-cross model, actual expenditures differ from planned expenditures by the amount of:

Suppose Congress passes legislation that significantly reduces taxes. Use the Keynesian-cross model to illustrate graphically the impact of a reduction in taxes on the equilibrium level of income. Be sure to label: i. the axes; ii. the curves; iii. the initial equilibrium values; iv. the direction the curve shifts; and v. the terminal equilibrium values. b. Explain in words what happens to equilibrium income as a result of the tax cut and the time horizon appropriate for this analysis.

Explain why a decrease in planned investment, which is a change in the goods market, will upset the equilibrium in the money market.

When firms experience unplanned inventory accumulation, they typically:

As an economy moves into a recession, income falls. Illustrate graphically the impact of a decrease in income on the equilibrium interest rate using the theory of liquidity preference and the market for real money balances. Be sure to label: i. the axes; ii. the curves; iii. the initial equilibrium values; iv. the direction the curve shifts; and v. the terminal equilibrium values. b. Explain in words what happens to the equilibrium interest rate as a result of the fall in income.

According to the analysis underlying the Keynesian cross, when planned expenditure exceeds income:

Both Keynesians and supply-siders believe a tax cut will lead to growth:

Explain what force moves the market back to equilibrium if the market is initially in disequilibrium in: a. the market for goods and services; b. the market for real money balances.

In the IS-LM model, which two variables are influenced by the interest rate?

The simple investment function shows that investment as increases.

The IS-LM model simultaneously determines equilibrium in two markets. a. Which two markets? b. What two variables adjust to bring equilibrium in the markets?

The equilibrium condition in the Keynesian-cross analysis in a closed economy is:

When planned expenditure is drawn on a graph as a function of income, the slope of the line is:

In the Keynesian-cross model, the equilibrium level of income is determined by:

In the Keynesian-cross model, if taxes are reduced by 250, then the equilibrium level of income:

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?

Suppose Congress decides to reduce the budget deficit by cutting government spending. Use the Keynesian-cross model to illustrate graphically the impact of a reduction in government purchases on the equilibrium level of income. Be sure to label: i. the axes; ii. the curves; iii. the initial equilibrium values; iv. the direction the curve shifts; and v. the terminal equilibrium values. b. Explain in words what happens to equilibrium income as a result of the cut in government spending and the time horizon appropriate for this analysis.

According to the theory of liquidity preference, if the demand for real money balances exceeds the supply of real money balances, individuals will:

According to the Keynesian-cross analysis, when there is a shift upward in the government-purchases schedule by an amount ∆G and the planned expenditure schedule by an equal amount, then equilibrium income rises by: one unit.