Exam 12: Aggregate Demand Ii: Applying the Is-Lm Model

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.

The increase in income in response to a fiscal expansion in the IS-LM is:

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:

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

Assume that an economy is described by the IS curve Y = 3,600 + 3G - 2T - 150r and the LM curve Y = 2 M/P + 100r [or r = 0.01Y - 0.02(M/P)]. The investment function for this economy is 1,000 - 50r. The consumption function is C = 200 + (2/3)(Y - T). Long-run equilibrium output for this economy is 4,000. The price level is 1.0. a. Assume that government spending is fixed at 1,200 . The government wants to achieve a level of investment equal to 900 and also achieve $Y = 4,000$ . What level of $r$ is needed for $I =$ 900 ? What levels of $T$ and $M$ must be set to achieve the two goals? What will be the levels of private saving, public saving, and national saving? (Hint: Check $C + I + G = Y$ ) b. Now assume that the government wants to cut taxes to 1,000 . With $G$ set at 1,200 , what will the interest rate be at $Y = 4,000$ ? What must be the value of $M$ ? What will $I$ be? What will be the levels of private, public, and national saving? (Hint: Check $C + I + G = Y$ ) c. Which set of policies may be referred to as tight fiscal, loose money? Which set of policies may be referred to as loose fiscal, tight money? Which "policy mix" most encourages investment?

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

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

Suppose that people finally realize that they must save a larger proportion of their income in order to retire and that they simultaneously begin to use new technology that allows them to reduce their holdings of real cash balances as a proportion of their income. Use the IS-LM model to illustrate graphically the impact of these two changes in household behavior on output and interest rates. Be sure to label: i. the axes; ii. the curves; iii. the initial equilibrium values; iv. the direction the curves shift; and v. the terminal equilibrium values.

If the demand for real money balances does not depend on the interest rate, then the LM curve:

When an economy expands its monetary and fiscal policies, how is the aggregate demand curve affected?

Use the following to answer questions : Exhibit: Policy Interaction -(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 _____.

How does a change in fiscal policy bring changes in the IS curve in a short-run equilibrium?

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.

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

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.

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

The LM curve can shift to the right if there is an increase in the supply of money or a fall in the price level. In which case is this movement along the aggregate demand curve, and in which case is this a shift of the aggregate demand curve? Explain.

Use the following to answer questions : Exhibit: IS-LM to Aggregate Demand -(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:

Other things equal, an expected deflation can change demand by:

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