Deck 11: Aggregate Demand I: Building the Islm Model

Question 1

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.

Answer 1

actual expenditure equals planned expenditure.

Question 2

In the Keynesian-cross model with an MPC > 0, 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.

Answer 2

increases by more than 250.

Question 3

In the Keynesian-cross model, actual expenditures equal:

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

Answer 3

GDP.

Question 4

According to classical theory, national income depends on _____, while Keynes proposed that _____ determines 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

Question 5

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 6

Exhibit: Keynesian Cross In this graph, if firms are producing at level Y₁, then inventories will _____, inducing firms to _____ production.

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

Question 7

According to the Keynesian-cross analysis, when there is a shift upward in the government-purchases schedule by an amount ΔG, then equilibrium income rises by:

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

Question 8

In the Keynesian-cross model, if the MPC equals 0.75, then a $2 billion increase in government spending increases planned expenditures by _____ and increases the equilibrium level of income by _____.

A)$2 billion; $4 billion
B)$0.75 billion; $1 billion
C)$0.75 billion; $0.75 billion
D)$1 billion; $4 billion

Question 9

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 10

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 in government spending and taxes or the determination of the supply of real money balances.

Question 11

Exhibit: Keynesian Cross In this graph, if firms are producing at level Y₃, then inventories will _____, inducing firms to _____ production.

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

Question 12

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.

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

In the Keynesian-cross model, fiscal policy has a multiplying 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 16

John Maynard Keynes wrote that low income and high unemployment in economic downturns should be blamed on:

A)low levels of capital.
B)an untrained labour force.
C)inadequate technology.
D)low aggregate demand.

Question 17

The IS-LM model takes _____ as exogenous.

A)the price level and national income
B)the price level
C)national income
D)the interest rate

Question 18

Exhibit: Keynesian Cross In this graph, the equilibrium levels of income and expenditure are:

A)Y₁ and PE₁.
B)Y₂ and PE₂.
C)Y₃ and PE₃.
D)Y₃ and PE₄.

Question 19

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

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

Question 20

The equilibrium of 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 21

In the Keynesian-cross model with a given MPC > 0, the government-expenditure multiplier _____ the tax multiplier.

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

Question 22

Based on the Keynesian model, one reason to support government 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 23

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

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

Question 24

An increase in government spending generally shifts the IS curve:

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 25

The Keynesian-cross analysis assumes 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 26

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 27

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 28

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 29

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

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

Question 30

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 31

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 32

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 33

Gary Becker's criticism of government spending on infrastructure as part of U.S. President Barack 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 34

An increase in taxes shifts the IS curve:

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 35

Along any given IS curve:

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

Question 36

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 37

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

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

Question 38

One argument in favour of tax cuts over spending-based fiscal stimulus is that:

A)tax cuts increase the MPC by a larger amount than government spending.
B)tax cuts temporarily increase planned spending, but government spending permanently increases private spending.
C)in theory the tax multiplier is larger than the government spending multiplier.
D)historically tax cuts have been more successful than spending-based fiscal stimulus.

Question 39

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 40

In the Keynesian-cross model, if the MPC equals 0.75, then a $3 billion decrease in taxes increases planned expenditures by _____ and increases the equilibrium level of income by _____.

A)$3 billion; $9 billion
B)$2.25 billion; $6.75 billion
C)$2.25 billion; $2.25 billion
D)$3 billion; $3 billion

Question 41

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 42

Exhibit: Market for Real Money Balances Based on the graph, the equilibrium levels of interest rates and real money balances are:

A)r₁ and M₁ / P₁
B)r₂ and M₂ / P₂
C)r₃ and M₂ / P₂
D)r₃ and M₃ / P₃

Question 43

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 44

The theory of liquidity preference states 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 45

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 46

Exhibit: Market for Real Money Balances Based on the graph, if the interest rate is r₃, then people will _____ bonds, and the interest rate will _____.

A)sell; rise
B)sell; fall
C)buy; rise
D)buy; fall

Question 47

Changes in fiscal policy shift the:

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

Question 48

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 by the central bank.

Question 49

Exhibit: Market for Real Money Balances Based on the graph, if the interest rate is r₁, then people will _____ bonds, and the interest rate will _____.

A)sell; rise
B)sell; fall
C)buy; rise
D)buy; fall

Question 50

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 51

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 52

Changes in monetary policy shift the:

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

Question 53

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

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

Question 54

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

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

Question 55

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 56

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 57

The theory of liquidity preference states 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 58

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 59

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.

Question 60

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 61

Assume that the money demand function is (M / P)^d = 2,200 - 200r, where r is the interest rate in percent. If the price level is fixed at P = 2, and the Bank of Canada wants to fix the interest rate at 7 percent, it should set the money supply at:

A)2,000.
B)1,800.
C)1,600.
D)1,400.

Question 62

Assume that the money demand function is (M / P)^d = 2,200 - 200r, where r is the interest rate in percent. The money supply M is 2,000, and the price level P is 2. If the price level is fixed and the supply of money is raised to 2,800, then the equilibrium interest rate will:

A)drop by 4 percent.
B)drop by 2 percent.
C)drop by 1 percent.
D)remain unchanged.

Question 63

Assume that the money demand function is (M / P)^d = 2,200 - 200r, where r is the interest rate in percent. The money supply M is 2,000, and the price level P is 2. The equilibrium interest rate is _____ percent.

A)2
B)4
C)6
D)8

Question 64

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 65

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 66

How can the government expenditure multiplier be reinterpreted in terms of the marginal propensity to save MPS = 1 - MPC?

Question 67

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 68

Two identical countries, Country A and Country B, can each be described by a Keynesian-cross model. The MPC is 0.7 in each country. Country A decides to increase spending by $2 billion, while Country B decides to cut taxes by $2 billion. In which country will the new equilibrium level of income be greater?

Question 69

Consider a closed economy to which the Keynesian-cross analysis applies. Consumption is given by the equation C = 200 + 2 / 3 (Y - T). Planned investment is 300, as are government spending and taxes.
a.If Y is 1,500, what is planned spending? What is inventory accumulation or decumulation? Should equilibrium Y be higher or lower than 1,500?
b.What is equilibrium Y?
c.What are equilibrium consumption, private saving, public saving, and national saving?
d.How much does equilibrium income decrease when G is reduced to 200? What is the multiplier for government spending?

Question 70

Using the Keynesian-cross analysis, assume that the consumption function is given by C = 200 + 0.7 (Y - T). If planned investment is 100 and T is 100, then the level of G needed to make equilibrium Y equal 1,000 is:

A)170.
B)200.
C)250.
D)350.

Question 71

In the money market, an increase in the money supply:

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

Question 72

In the Keynesian-cross analysis, if the consumption function is given by C = 20 + 0.7 (Y - T), and planned investment is 100, G is 100, and T is 100, then equilibrium Y is:

A)350.
B)600.
C)950.
D)1,100.

Question 73

The IS-LM model is generally used:

A)only in the short run.
B)only in the long run.
C)both in the short run and in the long run.
D)in determining the price level.

Question 74

Assume that the consumption function is given by C = 200 + 0.5 (Y - T), and the investment function is I = 1,000 - 200r, where r is measured in percent, G equals 300, and T equals 200.
a.What is the numerical formula for the IS curve?

Question 75

The diagram below shows how a rise in government expenditure (G) shifts the IS curve from IS₁ to IS₂. What are the levels of investments in Y₁ and Y₂ for a fixed r?

Question 76

In the Keynesian-cross analysis, assume that the analysis of taxes is changed so that taxes, T, are made a function of income, as in T = T + tY, where T and t are parameters of the tax code and t is positive but less than 1. As compared to a case where t is zero, the multiplier for government purchases in this case will:

A)not change.
B)be smaller.
C)be bigger.
D)be equal to 1.

Question 77

Equilibrium levels of income and interest rates are _____ related in the goods and services market, and equilibrium levels of income and interest rates are _____ related in the market for real money balances.

A)positively; positively
B)positively; negatively
C)negatively; negatively
D)negatively; positively

Question 78

Assume that money demand is given by (M / P)^d = 0.5Y - 100r, and (M / P)^s equals 800.
a.Write the LM curve two ways, expressing Y as a function of r and r as a function of Y.

Question 79

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 80

According to the Keynesian-cross analysis, if the marginal propensity to consume is 0.6 and government expenditures and autonomous taxes are both increased by 100, equilibrium income will rise by:

A)0.
B)100.
C)150.
D)250.