Deck 11: Measuring the Cost of Living

Question 1

The monetary transmission mechanism works through the effects of changes in the money supply on:

A)the budget deficit.
B)investment.
C)government expenditures.
D)taxation.

Answer 1

B

Question 2

In the IS-LM model when the Federal Reserve decreases the money supply, people bonds and the interest rate , leading to a(n) in investment and income.

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

Answer 2

C

Question 3

In the IS-LM model, a decrease in government purchases leads to a(n) _ in planned expenditures, a(n) _ in total income, a(n) in money demand, and a(n) _ in the equilibrium interest rate.

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

Answer 3

A

Question 4

In the IS-LM model under the usual conditions 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 5

If the money supply increases, then in the IS-LM analysis the _ curve shifts to the _ .

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

Question 6

If MPC = 0.75 (and there are no income taxes) when G increases by 100, then the IS curve for any given interest rate shifts to the right by:

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

Question 7

In the IS-LM model, the impact of an increase in government purchases in the goods market has ramifications in the money market, because the increase in income causes a(n) _ in money .

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

Question 8

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 9

In the IS-LM model when M rises but P remains constant, 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

Question 10

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

Question 11

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

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

Question 12

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 13

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

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

Question 14

If MPC = 0.75 (and there are no income taxes but only lump-sum taxes) when T decreases by 100, then the
IS curve for any given interest rate shifts to the right by:

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

Question 15

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 16

In the IS-LM model when taxation increases, 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

Question 17

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

A)always less than in the Keynesian-cross model.
B)less than in the Keynesian-cross model unless the LM curve is vertical.
C)less than in the Keynesian-cross model unless the LM curve is horizontal.
D)less than in the Keynesian-cross model unless the IS curve is vertical.

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

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

Question 20

The interaction of the IS curve and the LM curve together determine:

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

Question 21

How can the Fed 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 22

A tax cut combined with tight money, as was the case in the United States in the early 1980s, should lead to a:

A)rise in the real interest rate and a fall in investment.
B)fall in the real interest rate and a rise in investment.
C)rise in both the real interest rate and investment.
D)fall in both the real interest rate and investment.

Question 23

According to the IS-LM model, if Congress raises taxes but the Fed wants to hold the interest rate constant, then the Fed must the money supply.

A)increase
B)decrease
C)first increase and then decrease
D)first decrease and then increase

Question 24

If Congress passed a tax increase at the request of the president to reduce the budget deficit, but the Fed held the money supply constant, then the two policies together would generally lead to _ income and a _ interest rate.

A)lower; lower
B)lower; higher
C)no change in; lower
D)no change in; higher

Question 25

An increase in the money supply:

A)increases income and lowers the interest rate in both the short and long runs.
B)increases income in both the short and long runs, but leaves the interest rate unchanged in the long run.
C)lowers the interest rate in both the short and long runs, 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 26

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 and long runs.

Question 27

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

A)adopt a loose monetary policy but keep fiscal policy unchanged.
B)adopt a loose monetary policy and a loose fiscal policy.
C)adopt a loose monetary policy and a tight fiscal policy.
D)keep monetary policy unchanged but adopt a tight fiscal policy.

Question 28

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, which 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.

Question 29

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
Ms/P = Md/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 30

Use the IS-LM model to illustrate graphically the impact of the Pigou effect on the equilibrium level of income and interest rate during the Great Depression, when prices were falling.

Question 31

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 and long runs.

Question 32

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 33

Suppose Congress passes legislation that reduces taxes. Use the IS-LM model to illustrate graphically the impact of the tax reduction 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 34

If taxes are raised, but the Fed prevents income from falling by raising the money supply, then:

A)both consumption and investment remain unchanged.
B)consumption rises but investment falls.
C)investment rises but consumption falls.
D)both consumption and investment fall.

Question 35

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 Ms/P = Md/P = 0.4Y - 40r
Ms = 1,200
a. Write a numerical formula for the IS curve, showing Y as a function of r alone. (Hint: Substitute out C, I,
G, and T.)
b. Write a numerical formula for the LM curve, showing Y as a function of r alone. (Hint: Substitute out M/P.) c. What are the short-run equilibrium values of Y, r, Y - T, C, I, private saving, public saving, and national saving? Check by ensuring that C + I + G = Y and national saving equals I.
d. Assume that G increases by 200. By how much will Y increase in short-run equilibrium? What is the
government-purchases multiplier (the change in Y divided by the change in G)?
e. Assume that G is back at its original level of 1,000, but Ms (the money supply) increases by 200. By how much will Y increase in short-run equilibrium? What is the multiplier for money supply (the change in Y divided by the change in Ms)?

Question 36

Assume that an economy is described by the IS curve Y = 3,600 + 3G - 2T - 150r and the LM curve Y =
2M/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 and M = 1,200.
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?

Question 37

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.

Question 38

The monetary transmission mechanism in the IS-LM model is a process whereby an increase in the money supply increases the demand for goods and services:

A)directly.
B)by lowering the interest rate so that investment spending increases.
C)by raising the interest rate so that investment spending increases.
D)by increasing government spending on goods and services.

Question 39

Suppose Congress wishes to reduce the budget deficit by reducing government spending. Use the IS-LM model to illustrate graphically the impact of the reduction in government spending 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 40

According to the IS-LM model, if Congress raises taxes but the Fed wants to hold income constant, then the
Fed must the money supply.

A)increase
B)decrease
C)first increase and then decrease
D)first decrease and then increase

Question 41

Assume that initially everyone expects the price level to stay the same. Now the Federal Reserve 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 42

a. An economy is initially at the natural level of output. There is an increase in government spending. Use the IS-LM model to illustrate both the short-run and long-run impact of this policy change. Be sure to label: i. the axes; ii. the curves; iii. the initial equilibrium, iv. the short-run equilibrium, and v. the terminal equilibrium. b. Explain in words the short-run and long-run impact of the change in government spending on output and interest rates.

Question 43

Assume the economy is initially in a short-run equilibrium at a level of output below the natural rate. a.Use the IS-LM model to graphically illustrate:
1. how the economy will adjust in the long-run if the no-policy action is taken.
2. the long-run equilibrium if fiscal policy is used to return the economy to the natural rate of output.
b.Explain how investment, the interest rate, and the price level differ in the new long-run equilibrium in the two cases.

Question 44

Assume that the economy is initially in short-run equilibrium at a level of output above the natural rate. Use the IS-LM model to illustrate graphically how the levels of income and interest rates change as the economy returns to the natural rate of output in the long run.

Question 45

Use the IS-LM model to predict the short-run impact on the interest rate and output if the Fed pushes interest rates down at the same time that both consumption and investment fall due to a financial crisis. Illustrate your answer graphically. Be sure to label: i. the axes; ii. the curves; iii. the initial equilibrium; and iv. the direction the curves shift. Explain your answer in words.