Deck 32: Keynesian Economics and the Is-Lm Analysis

Question 1

What was John Maynard Keynes's primary message concerning recessions and depressions?

A) Governments should not intervene in the economy but leave the economy to recover of its own accord from a recession or depression.
B) Recessions and depressions can occur as a result of inadequate aggregate demand for goods and services.
C) Long-run policy intervention by governments is needed to avoid recessions and depressions.
D) Recessions and depressions are entirely monetary phenomena.

Answer 1

B

Question 2

In the Keynesian cross diagram the 45 degree line

A) has no economic significance.
B) connects all points where there is full employment in the economy.
C) connects all points where consumption spending would be equal to national income.
D) connects all points where spending on imports is equal to the value of export spending.

Answer 2

C

Question 3

A key element of Keynesian analysis relates to:

A) policies to reduce the difference between planned and actual spending and investment
B) using taxation as a means to influence the interest rate in an economy.
C) The similarities between short term fluctuations in macroeconomic variables and how they behave in the long run
D) the distinction between planned spending and investment and actual spending and investment

Answer 3

D

Question 4

Refer to figure 1 below. If the vertical distance labelled Z represents a deflationary gap then which of the following statements is true? Figure 1

A) Y₂ represents the full employment level of output and total expenditure must be reduced from C+I+G+(X-M)₂ to C+I+G+(X-M)₁ in order to increase output and employment.
B) Y₁ represents the full employment level of output and total expenditure must be reduced from C+I+G+(X-M)₂ to C+I+G+(X-M)₁ in order to increase output and employment.
C) Y₂ represents the full employment level of output and total expenditure must be increased from C+I+G+(X-M)₁ to C+I+G+(X-M)₂ in order to increase output and employment.
D) Y₁ represents the full employment level of output and total expenditure must be increased from C+I+G+(X-M)₁ to C+I+G+(X-M)₂ in order to increase output and employment.

Question 5

If the marginal propensity to consume in the economy is 0.8 and the government increases its spending this year by €10 billion, what will be the additional increase in expenditure in the economy next year?

A) €10 billion
B) €8 billion
C) €2 billion
D) €0.8 billion

Question 6

The LM curve connects points where the money market is in equilibrium and the demand for money is equal to the supply of money at different interest rates.

Question 7

Which of the following statements about Keynesian views is true?

A) Keynes' analysis was mainly concerned with the long-run
B) Keynes fully supported the classical view that markets were efficient and cleared quickly
C) Demand deficient output meant that governments had a responsibility to boost demand to maintain full employment in the short term
D) Responsibility for fiscal policy should be transferred to central banks because governments could not be trusted to implement tax changes appropriately in times of recession.

Question 8

The multiplier model implies that

A) additional spending by the government will be a multiple of the tax rise needed to fund the spending.
B) changes in autonomous spending will lead to an increase in national income which is greater than the initial increase in spending.
C) changes in government spending will always lead to a proportionate increase in national income.
D) there are no leakages from the circular flow of income.
E) aggregate demand rises by a constant multiple of the change in consumption spending.

Question 9

John Maynard Keynes' General Theory was an attempt to explain how economies operate at equilibrium in the long run.

Question 10

A deflationary gap exists when there is a difference between the price level in an economy and a fall in the level of national income.

Question 11

The IS curve measures points where the inflation rate and national income are the same.

Question 12

An increase in the demand for money causes a shift of the demand for money curve to the right and a movement along the LM curve reflecting a higher interest rate and level of national income.

Question 13

On a Keynesian cross diagram, the 45 degree line connects all points where consumption spending would be equal to national income.

Question 14

A deflationary gap occurs because

A) Governments set full employment output at too high a level.
B) Prices in the economy are too low to ensure that all resources are fully utilized in the economy.
C) The level of expenditure in an economy is less than that needed to maintain full employment output.
D) Planned spending turns out to equal actual spending above full employment output
E) There are not enough resources in the economy to meet consumption requirements.

Question 15

Which of the following statements about the 45 degree line is true?

A) The 45 degree line cuts the vertical axis at the level of autonomous expenditure in the economy.
B) The 45 degree line connects all points where interest rates and national income are equal.
C) The slope of the 45 degree line is determined by the marginal propensity to consume.
D) A steeper 45 degree line indicates an inflationary gap.
E) The 45 degree line connects all points where consumption spending would equal national income.

Question 16

If the economy was in equilibrium where an inflationary gap existed then Keynes would argue that governments should cut public spending and increase taxation to reduce the expenditure line to reduce the gap.

Question 17

Keynes believed that a key element of unemployment was a deficiency in the level of aggregate demand which governments could and should rectify.

Question 18

The government increases spending by €10 billion during a time of economic slowdown when output is less than full employment output. The marginal propensity to withdraw is 0.9. What is the value of the multiplier?

A) 0.1
B) 0.9
C) 1.1
D) 10

Question 19

The IS curve will be flatter the more responsive consumption and investment are to changes in interest rates.

Question 20

Planned spending includes the intended or desired spending by households and firms in the economy.

Question 21

In the money market, an increase in national income will, assuming all other things remain unchanged,

A) lead to a reduction in demand for money and a fall in the interest rate.
B) lead to an increase in demand for money and a rise in the interest rate.
C) lead to an increase in demand for money and a fall in the interest rate.
D) lead to a reduction in demand for money and a rise in the interest rate.

Question 22

General equilibrium in an economy occurs:

A) at a particular interest rate where the goods market and the money market are both in equilibrium.
B) when the equilibrium level of national income in the goods market is the same as that in the money market at full employment output.
C) when interest rates in the money market and the financial markets are the same.
D) when investment equals saving.

Question 23

The investment and saving line in the IS-LM model connects

A) points of equilibrium in the goods market at different interest rates.
B) points of equilibrium in the money market at different interest rates.
C) points of equilibrium in the goods market and the money market.
D) points at which investment and saving are equal.

Question 24

The liquidity and money (LM) curve has

A) a positive slope showing that the money market is in equilibrium at a higher interest rate when national income is higher.
B) a negative slope showing that the money market is in equilibrium at a lower interest rate when national income is higher.
C) a positive slope showing that the money supply is positively related to national income.
D) a negative slope showing that the money supply is negatively related to national income.

Question 25

Figure 4 ​ Refer to figure 4 above. Assuming that Y₂ represents a level of national income lower than the full employment level, and that inflation has remained unchanged after the event that caused the IS curve to shift, what should the monetary authorities do if they wish to reduce unemployment?

A) Increase money supply.
B) Reduce money supply.
C) Advise the government to raise taxes.
D) Advise the government to reduce taxes.

Question 26

The slope of the IS curve is dependent upon:

A) the marginal propensity to save
B) the slope of the expenditure line from which it is derived.
C) how often the central bank changes interest rates.
D) the proportionate change in autonomous spending
E) the responsiveness of consumption and investment to changes in interest rates.

Question 27

Which of the following statements about the liquidity and money (LM) curve is NOT true?

A) The LM curve will shift to the right if the monetary authorities increase the money supply, all other things being equal.
B) The LM curve will shift to the left if the general level of prices in the economy rises, all other things being equal.
C) The LM curve shows all combinations of interest rate and level of national income at which the money market is in equilibrium.
D) The LM curve is unaffected by inflation.

Question 28

If the economy is suffering from demand deficient unemployment then Keynes would recommend

A) Cutting long term interest rates in order to boost investment.
B) Increasing the level of government spending to shift the expenditure line upwards.
C) Changing the marginal propensity to consume to bring about equilibrium in the economy at full employment output.
D) Increasing imports to help boost national income by shifting the expenditure line upwards.

Question 29

In the IS-LM model, general equilibrium refers to a situation in which

A) there is full employment in an economy.
B) the goods market and money market in an economy are both in equilibrium.
C) the goods market and money market in an economy are both in equilibrium and there is full employment in that economy.
D) the markets for all goods and services in an economy are in equilibrium.

Question 30

A shift in the LM curve can occur because

A) interest rates change so frequently.
B) of contractions and expansions in the money supply.
C) of the strength of the velocity of circulation.
D) of a shift in the demand for money.

Question 31

The goods market is said to be in equilibrium when

A) the economy is operating at full employment.
B) planned expenditure is equal to actual income.
C) consumers' spending plus household saving is equal to national income.
D) The government's budget is neither in surplus or deficit.

Question 32

Which of the following will generate a multiplier effect in the European economy?

A) An increase in exports of luxury European cars to China.
B) An increase in investment in the French wine industry.
C) A reduction in consumer spending due to a sudden and substantial fall in European stock markets that reduces household wealth.
D) All of the above.

Question 33

Refer to figure 2 below. Which of the following statements is NOT true? Figure 2

A) The upward shift in the expenditure line from C+I+G+(X-M)₁ to C+I+G+(X-M)₂ and consequent increase in national income would result from a reduction in interest rates.
B) The upward shift in the expenditure line from C+I+G+(X-M)₁ to C+I+G+(X-M)₂ and consequent increase in national income would result from an increase in exports.
C) The upward shift in the expenditure line from C+I+G+(X-M)₁ to C+I+G+(X-M)₂ and consequent increase in national income would result from a reduction in saving.
D) The upward shift in the expenditure line from C+I+G+(X-M)₁ to C+I+G+(X-M)₂ and consequent increase in national income would result from a reduction in government expenditure.

Question 34

Which of the following will not weaken the value of the multiplier in an economy in response to a change in autonomous spending?

A) A rise in net imports.
B) A fall in the marginal propensity to consume.
C) An increase in the proportion of tax taken of every euro earned
D) An increase in the interest rate

Question 35

Refer to figure 3 below. Which statement about the two possible IS curves in figure 3 is true? Figure 3

A) The economy is in equilibrium where IS₁ and IS₂ intersect.
B) IS₁ represents an economy in which consumers' expenditure and investment spending are more sensitive to interest rate changes than they are in the economy represented by IS₂.
C) IS₁ represents an economy in which consumers' expenditure and investment spending are less sensitive to interest rate changes than they are in the economy represented by IS₂.
D) None of the above is true.

Question 36

IS stands for:

A) Investment and Spending
B) Imports and Spending.
C) Interest and Saving
D) Investment and Saving.

Question 37

In which of the following situations would the multiplier effect on a country's economy of a tax cut implemented by that country's government be greatest?

A) The country is very open to international trade and imports are high relative to GDP.
B) The country's citizens are affluent and tend to save a relatively high proportion of their income.
C) The country's citizens have relatively low incomes and spend little on foreign holidays or imported goods.
D) The country's citizens are cautious and sceptical, leading them to assume that the tax cut will soon be reversed.

Question 38

Figure 4 ​ Refer to figure 4 above. What could have caused the shift in the IS curve shown?

A) An increase in money supply.
B) A decrease in money supply.
C) A rise in tax.
D) A reduction in tax.

Question 39

Figure 4 ​ ​
Refer to figure 4 above. Figure 4 shows the IS-LM model. Which of the following statements about the figure is NOT true?

A) The figure shows the economy would be in general equilibrium when the interest rate is i₁ and the level of national income is Y₁.
B) The figure shows that an expansionary monetary policy will lead to an increase in national income and an increase in interest rates.
C) The figure shows that an expansionary fiscal policy will lead to an increase in national income and an increase in interest rates.
D) The figure shows the effect of an increase in autonomous expenditure.

Question 40

The slope of the expenditure line is dependent upon:

A) the marginal propensity to consume.
B) the marginal efficiency of capital.
C) how far the government decides to increase autonomous expenditure.
D) the slope of the 45 degree line.

Question 41

The IS-MP model differs from the IS-LM model in that it is assumed

A) central banks target inflation and set interest rates to meet such a target.
B) the money supply is endogenous.
C) price and wage stickiness do not exist.
D) governments instruct central banks on the level of the money supply and interest rates.

Question 42

What does the Keynesian cross diagram show?

Question 43

Explain the principle of general equilibrium.

Question 44

Suppose that the government increases expenditures by €150 billion while increasing taxes by €150 billion. Suppose that the MPC is 0.80 and that there are no crowding out or accelerator effects. What are the combined effects of these changes? Why is the combined change not equal to zero?

Question 45

What is the relationship between the production possibilities frontier and the deflationary gap?

Question 46

Assume that the economy is in equilibrium at an interest rate and level of national income where the IS curve cuts the LM curve. A large cut in government spending would be expected to:

A) increase interest rates and the level of national income.
B) reduce interest rates but increase the level of national income.
C) reduce interest rates and the level of national income.
D) shift the IS curve to the right.
E) leave the economy in an unchanged position because the marginal propensity to consume is constant.

Question 47

What did Keynes mean by an inflationary and deflationary gap?

Question 48

What was the relevance of Keynes reference to the statement that in the long run we are all dead?

Question 49

Explain how the aggregate demand curve is derived from the IS-LM model.

Question 50

Suppose that there are no crowding-out effects and the MPC is 0.9. By how much must the government increase expenditures to shift the aggregate demand curve right by €10 billion?

Question 51

If a central bank wants to reduce interest rates it will instruct its traders to:

A) instruct all financial institutions to adjust rates accordingly.
B) reduce liquidity in financial markets.
C) buy bonds on the open market.
D) carry out open market operations by buying shares on the stock exchange.

Question 52

In the IS-MP model, the MP curve is upward sloping from left to right because it is assumed that

A) central banks have no control over interest rates.
B) central banks will raise interest rates when national income rises in order to dampen inflationary pressure.
C) central banks will increase the money supply when national income rises in order to dampen inflationary pressure.
D) monetary policy can have no effect on national income.

Question 53

In the IS-LM model the money supply is assumed to be:

A) determined by the interest rate.
B) endogenous.
C) fixed by the government.
D) exogenous.

Question 54

Suppose that the government spends more on building new schools. What does this do to aggregate demand? How is your answer affected by the presence of the multiplier, crowding-out, taxes, and investment-accelerator effects?

Question 55

Assume a central bank has been charged with maintaining the price level at a rate of 2 per cent. For the past twelve months the inflation rate has been at target and interest rates have been stable but the government has been concerned over signs of a slowdown in economic activity. As a result the government has decided to increase its spending on infrastructure projects. If the central bank wishes to maintain interest rates (and inflation) at a stable rate what should it do in the light if this decision?

A) Nothing as changes in government spending on infrastructure does not affect consumer price inflation.
B) Expand the money supply to maintain interest rates at a level consistent with its forecast of consumer price inflation.
C) Reduce the money supply by an equal amount to counteract the increase in government spending.
D) Persuade the government that any additional spending must be financed purely by taxation so that monetary policy does not have to change.

Question 56

The supply of real money balances is given by the equation:

A) MV = PY
B) MP × 1/y
C) 1 / (1-MP)
D) M/P
E) P × M

Question 57

One of the main sources of disagreement amongst economists about macroeconomic policy is:

A) a fundamental disagreement about the role of taxation.
B) how far and how quickly macroeconomic variables adjust in response to changing economic conditions.
C) whether the marginal propensity to consume can be calculated accurately.
D) the fact that the IS-LM model has no relevance at all to a modern developed economy.

Question 58

Refer to figure 5 below. In figure 5, national income has fallen from its full employment level Y_F to a lower level, Y_U, at which there is unemployment. This may have been due to a decline in exports that has shifted the IS curve to the left. What might cause the LM curve to automatically move to the right and so move the economy back towards Y_F? Figure 5

A) A rise in the general level of prices in the economy.
B) A fall in the general level of prices in the economy.
C) A rise in government spending.
D) A reduction in taxes.

Question 59

What is the main difference between the IS-LM model and David Romer's IS-MP model?

Question 60

In the IS-LM model, a rise in the general level of prices will shift

A) the LM curve to the left.
B) the LM curve to the right.
C) the IS curve to the left.
D) both the IS and LM curves.