Deck 10: Aggregate Demand I: Building the Is-Lm Model

Question 1

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

A)liquidity preference.
B)the government-purchases multiplier.
C)unplanned inventory investment.
D)real money balances.

Answer 1

unplanned inventory investment.

Question 2

According to classical theory, national income depends on , while Keynes proposed that determined the level of national income.

A)aggregate demand; aggregate supply
B)aggregate supply; aggregate demand
C)monetary policy; fiscal policy
D)fiscal policy; monetary policy

Answer 2

aggregate supply; aggregate demand

Question 3

With planned expenditure and the equilibrium condition Y = PE drawn on a graph with income along the horizontal axis, if income exceeds expenditure, then income is to the of equilibrium income and there is unplanned inventory .

A)right; decumulation
B)right; accumulation
C)left; decumulation
D)left; accumulation

Answer 3

right; accumulation

Question 4

In the Keynesian-cross model, if government purchases increase by 100, then planned expenditures for any given level of income.

A)increase by 100
B)increase by more than 100
C)decrease by 100
D)increase, but by less than 100

Question 5

Two interpretations of the IS-LM model are that the model explains:

A)the determination of income in the short run when prices are fixed or what shifts the aggregate demand curve.
B)the short-run quantity theory of income or the short-run Fisher effect.
C)the determination of investment and saving or what shifts the liquidity preference schedule.
D)changes government spending and taxes or the determination of the supply of real money balances.

Question 6

When drawn on a graph with Y along the horizontal axis and PE along the vertical axis, the line showing planned expenditures rises to the:

A)right with a slope less than one.
B)right with a slope greater than one.
C)left with a slope less than one.
D)left with a slope greater than one.

Question 7

The Keynesian cross shows:

A)determination of equilibrium income and the interest rate in the short run.
B)determination of equilibrium income and the interest rate in the long run.
C)equality of planned expenditure and income in the short run.
D)equality of planned expenditure and income in the long run.

Question 8

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

A)income falls.
B)planned expenditure falls.
C)unplanned inventory investment is negative.
D)prices rise.

Question 9

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

A)supply of nominal money balances and demand for real balances
B)demand for real balances and government purchases
C)supply of nominal money balances and investment spending
D)demand for real money balances and investment spending

Question 10

Planned expenditure is a function of:

A)planned investment.
B)planned government spending and taxes.
C)planned investment, government spending, and taxes.
D)national income and planned investment, government spending and taxes.

Question 11

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

A)income equals consumption plus investment plus government spending.
B)planned expenditure equals consumption plus planned investment plus government spending.
C)actual expenditure equals planned expenditure.
D)actual saving equals actual investment.

Question 12

In the Keynesian-cross model, actual expenditures equal:

A)GDP.
B)the money supply.
C)the supply of real balances.
D)unplanned inventory investment.

Question 13

When firms experience unplanned inventory accumulation, they typically:

A)build new plants.
B)lay off workers and reduce production.
C)hire more workers and increase production.
D)call for more government spending.

Question 14

The IS curve plots the relationship between the interest rate and that arises in the market for .

A)national income; goods and services
B)the price level; goods and services
C)national income; money
D)the price level; money

Question 15

For the purposes of the Keynesian cross, planned expenditure consists of:

A)planned investment.
B)planned government spending.
C)planned investment and government spending.
D)planned investment, government spending, and consumption expenditures.

Question 16

The government-purchases multiplier indicates how much change(s) in response to a $1 change in government purchases.

A)the budget deficit
B)consumption
C)income
D)real balances

Question 17

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

A)zero.
B)between zero and one.
C)one.
D)greater than one.

Question 18

The variable that links the market for goods and services and the market for real money balances in the IS-LM model is the:

A)consumption function.
B)interest rate.
C)price level.
D)nominal money supply.

Question 19

In the Keynesian-cross model, if the MPC equals 0.75, then a $1 billion increase in government spending increases planned expenditures by and increases the equilibrium level of income by .

A)$1 billion; more than $1 billion
B)$.75 billion; more than $.75 billion
C)$.75 billion; $.75 billion
D)$1 billion; $1 billion

Question 20

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:

A)one unit.
B)∆G.
C)∆G divided by the quantity one minus the marginal propensity to consume.
D)∆G multiplied by the quantity one plus the marginal propensity to consume.

Question 21

In the Keynesian-cross model, if taxes are reduced by 100, then planned expenditures for any given level of income.

A)increase by 100
B)increase by more than 100
C)decrease by 100
D)increase, but by less than 100

Question 22

The simple investment function shows that investment as increases.

A)decreases; the interest rate
B)increases; the interest rate
C)decreases; government spending
D)increases; government spending

Question 23

The Keynesian-cross analysis assumes that planned investment:

A)is fixed and so does the IS analysis.
B)depends on the interest rate and so does the IS analysis.
C)is fixed, whereas the IS analysis assumes it depends on the interest rate.
D)depends on expenditure and so does the IS analysis.

Question 24

In the Keynesian-cross model, what adjusts to move the economy to equilibrium following a change in exogenous planned spending?

A)planned spending.
B)the interest rate.
C)production.
D)the price level.

Question 25

The tax multiplier indicates how much change(s) in response to a $1 change in taxes.

A)the budget deficit
B)consumption
C)income
D)real balances

Question 26

In the Keynesian-cross model, if the MPC equals 0.75, then a $1 billion decrease in taxes increases planned expenditures by and increases the equilibrium level of income by .

A)$1 billion; more than $1 billion
B)$.75 billion; more than $.75 billion
C)$.75 billion; $.75 billion
D)$1 billion; $1 billion

Question 27

In the Keynesian-cross model, a decrease in the interest rate planned investment spending and the equilibrium level of income.

A)increases; increases
B)increases; decreases
C)decreases; decreases
D)decreases; increases

Question 28

An explanation for the slope of the IS curve is that as the interest rate increases, the quantity of investment , and this shifts the expenditure function , thereby decreasing income.

A)increases; downward
B)increases; upward
C)decreases; upward
D)decreases; downward

Question 29

When drawn on a graph with income along the horizontal axis and the interest rate along the vertical axis, the IS curve generally:

A)is vertical.
B)is horizontal.
C)slopes upward and to the right.
D)slopes downward and to the right.

Question 30

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

A)and both agree it works through incentive effects.
B)but Keynesians believe it works through incentive effects whereas supply-siders believe it works through aggregate demand.
C)but Keynesians believe it works through aggregate demand whereas supply- siders believe it works through incentive effects.
D)and both agree it works through aggregate demand.

Question 31

In the Keynesian-cross model with a given MPC, the government-expenditure multiplier the tax multiplier.

A)is larger than
B)equals
C)is smaller than
D)is the inverse of the

Question 32

In the Keynesian-cross model, if government purchases increase by 250, then the equilibrium level of income:

A)increases by 250.
B)increases by more than 250.
C)decreases by 250.
D)increases, but by less than 250.

Question 33

Tax cuts stimulate by improving workers' incentive and expand by raising households' disposable income.

A)velocity; demand for loanable funds
B)demand for loanable funds; velocity
C)aggregate demand; aggregate supply
D)aggregate supply; aggregate demand

Question 34

After the Kennedy tax cut in 1964, real GDP:

A)fell and unemployment rose.
B)rose and unemployment fell.
C)and unemployment both rose.
D)and unemployment both fell.

Question 35

Along any given IS curve:

A)tax rates are fixed, but government spending varies.
B)government spending is fixed, but tax rates vary.
C)both government spending and tax rates vary.
D)both government spending and tax rates are fixed.

Question 36

According to the Keynesian-cross analysis, if MPC stands for marginal propensity to consume, then a rise in taxes of ∆T will:

A)decrease equilibrium income by ∆T.
B)decrease equilibrium income by ∆T/(1 - MPC).
C)decrease equilibrium income by (∆T)(MPC)/(1 - MPC).
D)not affect equilibrium income at all.

Question 37

In the Keynesian-cross model, fiscal policy has a multiplier effect on income because fiscal policy:

A)increases the amount of money in the economy.
B)changes income, which changes consumption, which further changes income.
C)is government spending and, therefore, more powerful than private spending.
D)changes the interest rate.

Question 38

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

A)the factors of production.
B)the money supply.
C)planned spending.
D)liquidity preference.

Question 39

An increase in the interest rate:

A)reduces planned investment, because the interest rate is the cost of borrowing to finance investment projects.
B)increases planned investment, because people who make money from interest have more money to invest.
C)has no effect on investment.
D)may be caused by a drop in investment demand.

Question 40

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

A)increases by 250.
B)increases by more than 250.
C)decreases by 250.
D)increases, but by less than 250.

Question 41

When Paul Volcker tightened the money supply:

A)the inflation rate immediately fell.
B)nominal interest rates fell in the short run.
C)nominal interest rates fell in the long run.
D)real balances rose in the short run.

Question 42

The theory of liquidity preference implies that, other things being equal, an increase in the real money supply will:

A)lower the interest rate.
B)raise the interest rate.
C)have no effect on the interest rate.
D)first lower and then raise the interest rate.

Question 43

An IS curve shows combinations of:

A)taxes and government spending.
B)nominal money balances and price levels.
C)interest rates and income that bring equilibrium in the market for real balances.
D)interest rates and income that bring equilibrium in the market for goods and services.

Question 44

The theory of liquidity preference implies that:

A)as the interest rate rises, the demand for real balances will fall.
B)as the interest rate rises, the demand for real balances will rise.
C)the interest rate will have no effect on the demand for real balances.
D)as the interest rate rises, income will rise.

Question 45

According to the theory of liquidity preference, the supply of nominal money balances:

A)is chosen by the central bank.
B)depends on the interest rate.
C)varies with the price level.
D)changes as the level of income changes.

Question 46

An increase in government spending generally shifts the IS curve, drawn with income along the horizontal axis and the interest rate along the vertical axis:

A)downward and to the left.
B)upward and to the right.
C)upward and to the left.
D)downward and to the right.

Question 47

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

A)sell interest-earning assets in order to obtain non-interest-bearing money.
B)purchase interest-earning assets in order to reduce holdings of non-interest- bearing money.
C)purchase fewer goods and services.
D)be content with their portfolios.

Question 48

Based on the Keynesian model, one reason to support spending increases over tax cuts as measures to increase output is that:

A)government spending increases the MPC more than tax cuts.
B)the government-spending multiplier is larger than the tax multiplier.
C)government spending increases do not lead to unplanned changes in inventories, but tax cuts do.
D)increases in government spending increase planned spending, but tax cuts reduce planned spending.

Question 49

If the interest rate is above the equilibrium value, the:

A)demand for real balances exceeds the supply.
B)supply of real balances exceeds the demand.
C)market for real balances clears.
D)demand for real balances increases.

Question 50

The IS curve shows combinations of that are consistent with equilibrium in the market for goods and services:

A)inflation and unemployment
B)the price level and real output
C)the interest rate and the level of income
D)the interest rate and real money balances

Question 51

When the LM curve is drawn, the quantity that is held fixed is:

A)the nominal money supply.
B)the real money supply.
C)government spending.
D)the tax rate.

Question 52

One argument in favor of tax cuts over spending on infrastructure to increase production is that:

A)tax cuts increase the MPC by a larger amount than spending on infrastructure.
B)tax cuts increase planned spending, but spending on infrastructure offsets private spending.
C)the tax multiplier is larger than the government spending multiplier.
D)it takes longer to implement spending on infrastructure than to implement tax cuts.

Question 53

Along an IS curve all of the following are always true except:

A)planned expenditures equal actual expenditures.
B)planned expenditures equal income.
C)the demand for real balances equals the supply of real balances.
D)there are no unplanned changes in inventories.

Question 54

Changes in fiscal policy shift the:

A) LM curve.
B)money demand curve.
C)money supply curve.
D)IS curve.

Question 55

According to the theory of liquidity preference, the supply of real money balances:

A)decreases as the interest rate increases.
B)increases as the interest rate increases.
C)increases as income increases.
D)is fixed.

Question 56

Gary Becker's criticism of government spending on infrastructure as part of President Obama's stimulus plan was that:

A)spending on infrastructure would not increase production in the economy.
B)there is a conflict between where spending on infrastructure would benefit employment and where infrastructure is most needed.
C)government spending on infrastructure is less effective in increasing production than an equal amount of private spending on infrastructure.
D)government spending on infrastructure only increases demand, but tax cuts increase demand and supply.

Question 57

The IS curve generally determines:

A)income.
B)the interest rate.
C)both income and the interest rate.
D)neither income nor the interest rate.

Question 58

An increase in taxes shifts the IS curve, drawn with income along the horizontal axis and the interest rate along the vertical axis:

A)downward and to the left.
B)upward and to the right.
C)upward and to the left.
D)downward and to the right.

Question 59

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

A)sell interest-earning assets in order to obtain non-interest-bearing money.
B)purchase interest-earning assets in order to reduce holdings of non-interest- bearing money.
C)purchase more goods and services.
D)be content with their portfolios.

Question 60

The IS curve shifts when all of the following economic variables change except:

A)the interest rate.
B)government spending.
C)tax rates.
D)the marginal propensity to consume.

Question 61

A decrease in the nominal money supply, other things being equal, will shift the LM curve:

A)upward and to the right.
B)downward and to the right.
C)downward and to the left.
D)upward and to the left.

Question 62

The intersection of the IS and LM curves determines the values of:

A) r, Y, and P, given G, T, and M.
B) r, Y, and M, given G, T, and P.
C) r and Y, given G, T, M, and P.
D) p and Y, given G, T, and M.

Question 63

According to the theory of liquidity preference, tightening the money supply will nominal interest rates in the short run, and according to the Fisher effect, tightening the money supply will nominal interest rates in the long run.

A)increase; increase
B)increase; decrease
C)decrease; decrease
D)decrease; increase

Question 64

The IS and LM curves together generally determine:

A)income only.
B)the interest rate only.
C)both income and the interest rate.
D)income, the interest rate, and the price level.

Question 65

At a given interest rate, an increase in the nominal money supply the level of income that is consistent with equilibrium in the market for real balances.

A)raises
B)lowers
C)does not change
D)may either raise or lower

Question 66

For any given interest rate and price level, an increase in the money supply:

A)lowers income.
B)raises income.
C)has no effect on income.
D)lowers velocity.

Question 67

The theory of liquidity preference implies that the quantity of real money balances demanded is:

A)negatively related to both the interest rate and income.
B)positively related to both the interest rate and income.
C)positively related to the interest rate and negatively related to income.
D)negatively related to the interest rate and positively related to income.

Question 68

An explanation for the slope of the LM curve is that as:

A)the interest rate increases, income becomes higher.
B)the interest rate increases, income becomes lower.
C)income rises, money demand rises, and a higher interest rate is required.
D)income rises, money demand rises, and a lower interest rate is required.

Question 69

The interest rate determines in the goods market and money in the money market.

A)government spending; demand
B)government spending; supply
C)investment spending; demand
D)investment spending; supply

Question 70

An increase in income raises money and the equilibrium interest rate.

A)demand; raises
B)demand; lowers
C)supply; raises
D)supply; lowers

Question 71

In the liquidity preference model, what adjusts to move the money market to equilibrium following a change in the money supply?

A)planned spending.
B)the interest rate.
C)production.
D)the price level.

Question 72

The LM curve generally determines:

A)income.
B)the interest rate.
C)both income and the interest rate.
D)neither income nor the interest rate.

Question 73

The LM curve, in the usual case:

A)is vertical.
B)is horizontal.
C)slopes down to the right.
D)slopes up to the right.

Question 74

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

A)upward and to the right.
B)downward and to the right.
C)downward and to the left.
D)upward and to the left.

Question 75

The LM curve shows combinations of that are consistent with equilibrium in the market for real money balances:

A)inflation and unemployment
B)the price level and real output
C)the interest rate and the level of income
D)the interest rate and real money balances

Question 76

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.

A)increase; increase
B)increase; decrease
C)decrease; decrease
D)decrease; increase

Question 77

A decrease in the real money supply, other things being equal, will shift the LM curve:

A)downward and to the left.
B)upward and to the left.
C)downward and to the right.
D)upward and to the right.

Question 78

An LM curve shows combinations of:

A)taxes and government spending.
B)nominal money balances and price levels.
C)interest rates and income, which bring equilibrium in the market for real money balances.
D)interest rates and income, which bring equilibrium in the market for goods and services.

Question 79

Changes in monetary policy shift the:

A)LM curve.
B)planned spending curve.
C)money demand curve.
D)IS curve.

Question 80

With the real money supply held constant, the theory of liquidity preference implies that a higher income level will be consistent with:

A)no change in the interest rate.
B)a lower interest rate.
C)a higher interest rate.
D)first a lower and then a higher interest rate.