Deck 12: Aggregate Demand Ii: Applying the Islm Model

Question 1

In the IS-LM model when M / P rises, in short-run equilibrium, in the usual case the interest rate _____ and output _____.

A)rises; falls
B)rises; rises
C)falls; rises
D)falls; falls

Answer 1

falls; rises

Question 2

If MPC = 0.6 (and there are no income taxes) when G increases by 200, then the IS curve for any given interest rate shifts to the right by:

A)200.
B)300.
C)400.
D)500.

Answer 2

500.

Question 3

In the IS-LM model when M remains constant but P rises, in short-run equilibrium, in the usual case the interest rate _____ and output _____.

A)rises; falls
B)rises; rises
C)falls; rises
D)falls; falls

Answer 3

rises; falls

Question 4

Exhibit: IS-LM Fiscal Policy Based on the graph, starting from equilibrium at interest rate r₁ and income Y₁, an increase in government spending would generate the new equilibrium combination of interest rate and income:

A)r₂, Y₂
B)r₃, Y₂
C)r₂, Y₃
D)r₃, Y₃

Question 5

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, then in order to keep the interest rate constant, the Bank of Canada should _____ the money supply, shifting to _____.

A)increase; LM₂
B)decrease; LM₂
C)increase; LM₃
D)decrease; LM₃

Question 6

The interaction of the IS curve and the LM curve determines:

A)the price level and the inflation rate.
B)the level of output and the price level.
C)investment and the money supply.
D)the equilibrium level of the interest rate and output.

Question 7

In the IS-LM analysis, the increase in income resulting from a tax cut is _____ the increase in income resulting from an equal rise in government spending.

A)usually less than
B)usually greater than
C)usually equal to
D)sometimes less and sometimes greater than

Question 8

Exhibit: IS-LM Monetary Policy Based on the graph, starting from equilibrium at interest rate r₁ and income Y₁, an increase in the money supply would generate the new equilibrium combination of interest rate and income:

A)r₂, Y_2.
B)r₃, Y_2.
C)r₂, Y_3.
D)r₃, Y_3.

Question 9

Exhibit: IS-LM Monetary Policy Based on the graph, starting from equilibrium at interest rate r₁ and income Y₁, a decrease in the money supply would generate the new equilibrium combination of interest rate and income:

A)r₂, Y₂
B)r₃, Y₂
C)r₂, Y₃
D)r₃, Y₃

Question 10

In the IS-LM model when the Bank of Canada decreases the money supply, the public _____ bonds, and the interest rate _____, leading to a(n) _____ in investment and income. This is called the monetary transmission mechanism.

A)buy; rises; increase
B)sell; falls; decrease
C)sell; rises; decrease
D)buy; rises; decrease

Question 11

In the IS-LM model in a closed economy, an increase in government spending increases the interest rate and crowds out:

A)prices.
B)investment.
C)the money supply.
D)taxes.

Question 12

Exhibit: IS-LM Fiscal Policy Based on the graph, starting from equilibrium at interest rate r₁ and income Y₁, a tax cut would generate the new equilibrium combination of interest rate and income:

A)r₂, Y_2.
B)r₃, Y_2.
C)r₂, Y_3.
D)r₃, Y_3.

Question 13

Using the IS-LM analysis, if the LM curve is not horizontal, the multiplier for an increase in government spending is _____ for an increase in government purchases using the Keynesian-cross analysis.

A)larger than the multiplier
B)the same as the multiplier
C)smaller than the multiplier
D)sometimes larger and sometimes smaller than the multiplier

Question 14

Exhibit: IS-LM Fiscal Policy Based on the graph, starting from equilibrium at interest rate r₁ and income Y₁, a decrease in government spending would generate the new equilibrium combination of interest rate and income:

A)r₂, Y_2.
B)r₃, Y_2.
C)r₂, Y_3.
D)r₁, Y_2.

Question 15

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, then in order to keep output constant, the Bank of Canada should _____ the money supply, shifting to _____.

A)increase; LM₂
B)decrease; LM₂
C)increase; LM₃
D)decrease; LM₃

Question 16

In the IS-LM model, changes in taxes initially affect planned expenditures through:

A)consumption.
B)investment.
C)government spending.
D)the interest rate.

Question 17

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 Bank of Canada does not change the money supply, the new equilibrium combination of interest and income will be _____.

A)r₁, Y₂
B)r₂, Y₃
C)r₃, Y₃
D)r₃, Y₄

Question 18

The reason that the income response to a fiscal expansion is generally less in the IS-LM model than it is in the Keynesian-cross model is that the Keynesian-cross model assumes that:

A)investment is not affected by the interest rate, whereas in the IS-LM model fiscal expansion raises the interest rate and crowds out investment.
B)investment is not affected by the interest rate, whereas in the IS-LM model fiscal expansion lowers the interest rate and crowds out investment.
C)investment is autonomous, whereas in the IS-LM model fiscal expansion encourages higher investment, which raises the interest rate.
D)the price level is fixed, whereas in the IS-LM model it is allowed to vary.

Question 19

If the LM curve is vertical and government spending rises by G, in the IS-LM analysis, then equilibrium income rises by:

A)G / (1 - MPC).
B)more than zero but less than G / (1 - MPC).
C)G.
D)zero.

Question 20

If MPC = 0.6 (and there are no income taxes but only lump-sum taxes) when T decreases by 200, then the IS curve for any given interest rate shifts to the right by:

A)100.
B)200.
C)300.
D)400.

Question 21

One policy response to an economic slowdown is to cut taxes. This policy response can be represented in the IS-LM model by shifting the _____ curve to the _____.

A)LM; right
B)LM; left
C)IS; right
D)IS; left

Question 22

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.

A)increase; lower
B)increase; raise
C)lower; lower
D)lower; raise

Question 23

In the IS-LM model, a decrease in the interest rate would be the result of a(n):

A)increase in the money supply.
B)increase in government purchases.
C)decrease in taxes.
D)increase in money demand.

Question 24

If the short-run IS-LM equilibrium occurs at a level of income below the natural level of output, then in the long run the price level will _____, shifting the _____ curve to the right and returning output to the natural level.

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

Question 25

The economic slowdown in Canada in 2014 can be explained in part by a decline in investment and exports. Both of these shocks can be represented in the IS-LM model by shifting the _____ curve to the _____.

A)LM; right
B)LM; left
C)IS; right
D)IS; left

Question 26

In the IS-LM model, a decrease in output would be the result of a(n):

A)decrease in taxes.
B)increase in the money supply.
C)increase in money demand.
D)increase in government purchases.

Question 27

One policy response to the economic slowdown in Canada in 2008-2009 was to increase money growth. This policy response can be represented in the IS-LM model by shifting the _____ curve to the _____.

A)LM; right
B)LM; left
C)IS; right
D)IS; left

Question 28

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.

A)increase; lower
B)increase; raise
C)lower; lower.
D)lower; raise

Question 29

An economic change that does not shift the aggregate demand curve is a change in:

A)the money supply.
B)the investment function.
C)the price level.
D)taxes.

Question 30

A decrease in the price level shifts the _____ curve to the right, and the aggregate demand curve _____.

A)IS; shifts to the right
B)IS; does not shift
C)LM; shifts to the right
D)LM; does not shift

Question 31

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

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

Question 32

The aggregate demand curve generally slopes downward and to the right because, for any given money supply M, a higher price level P causes a _____ real money supply M / P, which _____ the interest rate and _____ spending.

A)lower; raises; reduces
B)higher; lowers; increases
C)lower; lowers; increases
D)higher; raises; reduces

Question 33

A change in income in the IS-LM model resulting from a change in the price level is represented by a _____ aggregate demand curve, while a change in income in the IS-LM model for a given price level is represented by a _____ aggregate demand curve.

A)movement along the; shift in the
B)shift in the; movement along the
C)vertical; horizontal
D)horizontal; vertical

Question 34

Exhibit: Short Run to Long Run Based on the graph, if the economy starts from a short-term equilibrium at A, then the long-run equilibrium will be at _____, with a _____ price level.

A)B; higher
B)B; lower
C)C; higher
D)C; lower

Question 35

Exhibit: Short Run to Long Run Based on the graph, if the economy starts from a short-term equilibrium at D, then the long-run equilibrium will be at _____, with a _____ price level.

A)B; higher
B)B; lower
C)C; higher
D)C; lower

Question 36

A tax cut shifts the _____ curve to the right, and the aggregate demand curve _____.

A)IS; shifts to the right
B)IS; does not shift
C)LM; shifts to the right
D)LM; does not shift

Question 37

Exhibit: IS-LM to Aggregate Demand Based on the graph, which is the correct ordering of the price levels and money supplies?

A)P₁ > P₂ and M₁ > M₂
B)P₁ > P₂ and M₁ < M₂
C)P₁ < P₂ and M₁ > M₂
D)P₁ < P₂ and M₁ < M₂

Question 38

Starting from a short-run equilibrium greater than the natural rate of output, as the economy returns to a long-run equilibrium:

A)both output and the price level will increase.
B)output will decrease, but the price level will increase.
C)output will increase, but the price level will decrease.
D)both output and the price level will decrease.

Question 39

A movement along an aggregate demand curve corresponds to a change in income in the IS-LM model _____, while a shift in an aggregate demand curve corresponds to a change in income in the IS-LM model _____.

A)resulting from a change in monetary policy; resulting from a change in fiscal policy
B)resulting from a change in fiscal policy; resulting from a change in monetary policy
C)at a given price level; resulting from a change in the price level
D)resulting from a change in the price level; at a given price level

Question 40

An increase in the money supply shifts the _____ curve to the right, and the aggregate demand curve _____.

A)IS; shifts to the right
B)IS; does not shift
C)LM; shifts to the right
D)LM; does not shift

Question 41

The LM curve is steeper the _____ the interest sensitivity of money demand and the _____ the effect of income on money demand.

A)greater; greater
B)greater; smaller
C)smaller; smaller
D)smaller; greater

Question 42

The debt-deflation hypothesis explains the fall in income as a consequence of unexpected deflation transferring wealth _____, and that creditors have a _____ propensity to consume than debtors.

A)from debtors to creditors; smaller
B)from debtors to creditors; larger
C)from creditors to debtors; smaller
D)from creditors to debtors; larger

Question 43

In the IS-LM model, starting with zero expected inflation, if expected inflation becomes negative, then the:

A)IS curve shifts leftward.
B)IS curve shifts rightward.
C)LM curve shifts leftward.
D)LM curve shifts rightward.

Question 44

The Pigou effect suggests that falling prices will increase income because real balances influence _____ and will shift the _____ curve.

A)money demand; LM
B)the money supply; LM
C)consumer spending; IS
D)government spending; IS

Question 45

If the demand function for money is M / P = 0.2Y - 200r, and if M / P increases by 100, then the LM curve for any given interest rate shifts to the:

A)left by 100.
B)left by 500.
C)right by 100.
D)right by 500.

Question 46

If the demand function for money is M / P = 0.5Y - 100r, then the slope of the LM curve is:

A)0.001.
B)0.005.
C)0.01.
D)0.05.

Question 47

Analysis of the short run and long run indicates that the _____ assumptions are most appropriate in _____.

A)classical; both the short run and the long run
B)Keynesian; both the short run and the long run
C)classical; the short run, whereas the Keynesian assumptions are most appropriate in the long run
D)Keynesian; the short run, whereas the classical assumptions are most appropriate in the long run

Question 48

The slope of the IS curve depends on:

A)the interest sensitivity of investment and the amount of government spending.
B)the interest sensitivity of investment and the marginal propensity to consume.
C)the interest sensitivity of investment and the tax rates.
D)tax rates and government spending.

Question 49

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

A)lowering the demand for money, thus shifting the LM curve.
B)increasing the demand for money, thus shifting the LM curve.
C)raising the real interest rate for any given nominal interest rate, thus reducing desired investment.
D)lowering the real interest rate for any given nominal interest rate, thus increasing desired investment.

Question 50

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 shift:

A)only the LM curve.
B)only the IS curve.
C)both the LM and the IS curves.
D)neither the LM nor the IS curve.

Question 51

A liquidity trap occurs when:

A)banks have too much currency and close their doors to new customers.
B)the central bank mistakenly prints too much money, generating hyperinflation.
C)interest rates fall so low that monetary policy is no longer effective.
D)dams and locks are built to prevent flooding.

Question 52

If money demand does not depend on the interest rate, then the LM curve is _____, and _____ policy has no effect on output.

A)horizontal; fiscal
B)vertical; fiscal
C)horizontal; monetary
D)vertical; monetary

Question 53

The debt-deflation theory of the Great Depression suggests that an _____ deflation redistributes wealth in such a way as to _____ spending on goods and services.

A)unexpected; reduce
B)unexpected; increase
C)expected; reduce
D)expected; increase

Question 54

Other things equal, a given change in government spending has a larger effect on demand the:

A)flatter the LM curve.
B)steeper the LM curve.
C)smaller the interest sensitivity of money demand.
D)larger the income sensitivity of money demand.

Question 55

The money hypothesis suggests that the Great Depression was caused by a:

A)leftward shift in the IS curve.
B)rightward shift in the IS curve.
C)leftward shift in the LM curve.
D)rightward shift in the LM curve.

Question 56

One explanation for the impact of expected price changes on the level of output is that an increase in expected deflation _____ the nominal interest rate and _____ the real interest rate, so that investment spending declines.

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

Question 57

During the financial crisis of 2008-2009, many financial institutions in Canada reduced the amount of loans, even to creditworthy customers, which could be represented in the IS-LM model as a(n):

A)expansionary shift in the IS curve.
B)contractionary shift in the IS curve.
C)expansionary shift in the LM curve.
D)contractionary shift in the LM curve.

Question 58

Investment depends on the _____ interest rate, and money demand depends on the _____ interest rate.

A)real; real
B)nominal; nominal
C)real; nominal
D)nominal; real

Question 59

A given increase in taxes shifts the IS curve more to the left the:

A)larger the marginal propensity to consume.
B)smaller the marginal propensity to consume.
C)larger the government spending.
D)smaller the government spending.

Question 60

Other things equal, a given change in government spending has a larger effect on demand the:

A)flatter the IS curve.
B)steeper the IS curve.
C)larger the interest sensitivity of expenditure demand.
D)smaller the interest sensitivity of money demand.

Question 61

If the IS curve is given by Y = 1,700 - 100r and the LM curve is given by Y = 500 + 100r, then equilibrium income and interest rate are given by:

A)Y = 1,100, r = 6 percent.
B)Y = 1,200, r = 5 percent.
C)Y = 1,000, r = 5 percent.
D)Y = 1,100, r = 5 percent.

Question 62

Economists who believe that monetary policy is more potent than fiscal policy argue that the:

A)responsiveness of money demand to the interest rate is large.
B)responsiveness of money demand to the interest rate is small.
C)IS curve is nearly vertical.
D)LM curve is nearly horizontal.

Question 63

An increase in government spending raises income:

A)and the interest rate in the short run but leaves both unchanged in the long run.
B)in the short run but leaves it unchanged in the long run, while lowering investment.
C)in the short run but leaves it unchanged in the long run, while lowering consumption.
D)and the interest rate in both the short run and in the long run.

Question 64

Assume the following model of the economy, with the price level fixed at 1.0:
​
​
C = 0.8(Y - T)
T = 1,000
​
I = 800 - 20r
G = 1,000
​
Y = C + I + G
M^s / P = M^d / P = 0.4Y - 40r
​
M^s = 1,200
​
​
a.Write a formula for the IS curve, showing Y as a function of r alone.

Question 65

Two identical countries, Alpha and Beta, can be described by the IS-LM model in the short run. The governments of both countries cut taxes by the same amount. The Central Bank of Alpha follows a policy of holding a constant money supply. The Central Bank of Beta follows a policy of holding a constant interest rate. Compare the impact of the tax cut on income and interest rates in the two countries.

Question 66

Economists who believe that fiscal policy is more potent than monetary policy argue that the:

A)responsiveness of investment to the interest rate is small.
B)responsiveness of investment to the interest rate is large.
C)IS curve is nearly horizontal.
D)LM curve is nearly vertical.

Question 67

An increase in the money supply:

A)increases income and lowers the interest rate in both the short run and in the long run.
B)increases income in both the short run and in the long run but leaves the interest rate unchanged in the long run.
C)lowers the interest rate in both the short run and in the long run but leaves income unchanged in the long run.
D)lowers the interest rate and increases income in the short run but leaves both unchanged in the long run.

Question 68

According to the IS-LM model, when the government increases taxes and government purchases by equal amounts:

A)income, the interest rate, consumption, and investment are unchanged.
B)income and the interest rate rise, whereas consumption and investment fall.
C)income and the interest rate fall, whereas consumption and interest rise.
D)income, the interest rate, consumption, and investment all rise.

Question 69

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?

Question 70

If the IS curve is given by Y = 1,700 - 100r, the money demand function is given by (M/P)^d = Y - 100r, the money supply is 1,000, and the price level is 2, then if the money supply is raised to 1,200, equilibrium income rises by:

A)200 and the interest rate falls by 2 percent.
B)100 and the interest rate falls by 1 percent.
C)50 and the interest rate falls by 0.5 percent.
D)200 and the interest rate remains unchanged.

Question 71

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 behaviour 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.

Question 72

Assume that initially everyone expects the price level to stay the same. Now the Bank of Canada announces that it will increase the rate of money growth in one year. People now expect inflation. Use the IS-LM model to illustrate graphically the impact of expected inflation on the level of output and on the real and nominal interest rates.

Question 73

Assume that an economy is characterized by the following equations:
C = 100 + (2 / 3) (Y - T)
T = 600
G = 500
I = 800 - (50 / 3) r
M^s / P = M^d / P = 0.5Y - 50r
​
a.Write the numerical IS curve for the economy, expressing Y as a numerical function of G, T, and r.
b.Write the numerical LM curve for this economy, expressing r as a function of Y and M / P.
c.Solve for the equilibrium values of Y and r, assuming P = 1.0 and M = 1,200. How do they change when P = 2.0? Check by computing C, I, and G.
d.Write the numerical aggregate demand curve for this economy, expressing Y as a function of G, T, and M / P.

Question 74

If neither investment nor consumption depends on the interest rate, then the IS curve is _____, and _____ policy has no effect on output.

A)vertical; monetary
B)horizontal; monetary
C)vertical; fiscal
D)horizontal; fiscal

Question 75

How can the Bank of Canada keep the economy from falling into a recession if the budget deficit is reduced? Use the IS-LM model to illustrate graphically the impact of both the fiscal policy reducing the deficit and the monetary policy, which prevents output from falling. 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.

Question 76

An increase in money supply shifts the LM curve to the right, but an increase in money demand shifts the LM curve to the left. Explain why there is a difference.

Question 77

A decrease in government spending reduces output more in the Keynesian-cross model than in the IS-LM model. Explain why this is true.

Question 78

An increase in taxes lowers income:

A)and the interest rate in the short run but leaves both unchanged in the long run.
B)in the short run but leaves it unchanged in the long run, while increasing consumption and lowering investment.
C)in the short run but leaves it unchanged in the long run, while lowering consumption and increasing investment.
D)and the interest rate in both the short run and in the long run.

Question 79

If consumption is given by C = 200 + 0.75(Y - T) and investment is given by I = 200 - 25r, then the formula for the IS curve is:

A)Y = 400 - 0.75T - 25r + G.
B)Y = 1,600 - 3T - 100r + 4G.
C)Y = 400 + 0.75T - 25r - G.
D)Y = 1,600 + 3T - 100r - 4G.

Question 80

Use the IS-LM model to illustrate graphically the impact on output and interest rates of a one-time increase in the price level due to a large increase in oil prices. 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.