Exam 12: The Determination of Aggregate Output, the Price Level, and the Interest Rate

Suppose the investment demand function is given as the following algebraic function: I = 300 - 1000r where r is the interest rate. Calculate the amount of investment that would take place at an interest rate of ten percent. How much investment would there be if interest rates rose to fifteen percent?

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Question 1

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The level of investment at a ten percent interest rate would be 300 - 1000(.10) = 200. If the interest rate rises to fifteen percent the level of investment will fall to 300 - 1000(.15) = 150.

Discuss the two links between the goods market and the money market.

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Question 2

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The first link exists because the demand for money depends on income. As aggregate output increases so does income. With the interest rate held constant this leads to an increase in money demand. The second link is between planned investment spending and the interest rate. In general, the higher the interest rate, the lower the level of planned investment and vice versa.

Suppose investment becomes less responsive to (i.e., sensitive to) changes in the interest rate. What effect will this have on the effectiveness of fiscal policy? Specifically, what will happen to the output effects of a given change in government spending?

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Question 3

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The effectiveness of fiscal policy will increase. The answer to this question is related to the crowding-out effects of fiscal policy. A fiscal expansion will cause an increase in Y and an increase in r. The higher r will cause a reduction in I partially offsetting the increase in G. If I does not fall as much, there will be less crowding-out and the increase in Y will be larger.

Explain the two key links between the goods market and the money market.

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Question 4

Indicate the effect of each of the following policies on the variables: Y, C, S, r, I, Ms, and Md. (a) The government reduces the personal income tax rates. (b) Firms become more pessimistic about future sales.

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Question 5

Graphically illustrate the impact of a decrease and increase in the interest rate on aggregate expenditure. On your graph, illustrate the impact of an increase and decrease in the interest rate upon aggregate expenditure. Summarize the relationship among changes in the rate of interest (r), the change in planned investment spending (I), its impact on the aggregate expenditure function (AE), and the multiple effect on income (Y).

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Question 6

Explain why changes in the goods market may have side effects in the money market.

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Question 7

List four determinants of planned investment.

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Question 8

What action could the Fed take to reduce the crowding-out effect of an expansionary fiscal policy?

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Question 9

In addition to the rate of interest, what other conditions affect the level of planned investment? Explain how these factors affect planned investment spending. (a) Expectations regarding business and overall economic conditions (b) Capital utilization rates (c) Relative labor and capital costs

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Question 10

Summarize the effects of an expansionary fiscal policy in the aggregate expenditure model. That is graphically illustrate the effects of an expansionary fiscal policy on the equilibrium level of output.

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Question 11

Explain the "crowding-out effect."

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Question 12

Explain what the aggregate demand curve is and the relationship between the price level and aggregate output.

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Question 13

Explain the role of expectations and "animal spirits" on investment decisions.

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Question 14

How much crowding out would be expected from an expansionary fiscal policy if investment was completely insensitive to the interest rate: that is independent of the interest rate? Explain your answer.

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Question 15

Assume the following graph for money supply and money demand. Explain the adjustment process that would take place in this money market if the interest rate is 12 percent. Make sure that your answer includes a discussion of what happens to money balances and bond prices.

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Question 16

Assume the Federal Reserve contracted the money supply in the face of high deficit spending on the part of Congress. Would this lessen or aggragavate the crowding out problem? Explain.

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Question 17

The textbook discusses the "crowding out effect". Can you think of any circumstances in which just the opposite effect could take place?

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Question 18

Draw the LM curve and explain its shape.

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Question 19

Describe the chain of events that are likely to unfold when the government reduces net taxes. Explain your answer in terms of its impact on aggregate output, the demand for money, the interest rate and planned investment.

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Question 20

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Discuss the two links between the goods market and the money market.

Suppose investment becomes less responsive to (i.e., sensitive to) changes in the interest rate. What effect will this have on the effectiveness of fiscal policy? Specifically, what will happen to the output effects of a given change in government spending?

Explain the two key links between the goods market and the money market.

Indicate the effect of each of the following policies on the variables: Y, C, S, r, I, Ms, and Md. (a) The government reduces the personal income tax rates. (b) Firms become more pessimistic about future sales.

Explain why changes in the goods market may have side effects in the money market.

List four determinants of planned investment.

What action could the Fed take to reduce the crowding-out effect of an expansionary fiscal policy?

In addition to the rate of interest, what other conditions affect the level of planned investment? Explain how these factors affect planned investment spending. (a) Expectations regarding business and overall economic conditions (b) Capital utilization rates (c) Relative labor and capital costs

Summarize the effects of an expansionary fiscal policy in the aggregate expenditure model. That is graphically illustrate the effects of an expansionary fiscal policy on the equilibrium level of output.

Explain the "crowding-out effect."

Explain what the aggregate demand curve is and the relationship between the price level and aggregate output.

Explain the role of expectations and "animal spirits" on investment decisions.

How much crowding out would be expected from an expansionary fiscal policy if investment was completely insensitive to the interest rate: that is independent of the interest rate? Explain your answer.

Assume the following graph for money supply and money demand. Explain the adjustment process that would take place in this money market if the interest rate is 12 percent. Make sure that your answer includes a discussion of what happens to money balances and bond prices.

Assume the Federal Reserve contracted the money supply in the face of high deficit spending on the part of Congress. Would this lessen or aggragavate the crowding out problem? Explain.

The textbook discusses the "crowding out effect". Can you think of any circumstances in which just the opposite effect could take place?

Draw the LM curve and explain its shape.

Describe the chain of events that are likely to unfold when the government reduces net taxes. Explain your answer in terms of its impact on aggregate output, the demand for money, the interest rate and planned investment.

The Scope and Method of Economics

The Economic Problem: Scarcity and Choice

Demand, Supply, and Market Equilibrium

Demand and Supply Applications

Introduction to Macroeconomics

Measuring National Output and National Income

Unemployment, Inflation, and Long-Run Growth

Aggregate Expenditure and Equilibrium Output

The Government and Fiscal Policy

The Money Supply and the Federal Reserve System

Money Demand and the Equilibrium Interest Rate

Policy Effects and Costs Shocks in the Asad Model

The Labor Market in the Macroeconomy

Financial Crises, Stabilization, and Deficits

Household and Firm Behavior in the Macroeconomy: a Further Look

Long-Run Growth

Alternative Views in Macroeconomics

International Trade, Comparative Advantage, and Protectionism

Open-Economy Macroeconomics: the Balance of Payments and Exchange Rates

Economic Growth in Developing and Transitional Economies

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