Deck 12: Aggregate Demand Ii: Applying the Is-Lm Model

Question 1

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.

Answer 1

zero.

Question 2

Use the following to answer questions
Exhibit: IS-LM Fiscal Policy
(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, Y₂
B) r₃, Y₂
C) r₂, Y₃
D) r₃, Y₃

Answer 2

r₃, Y₂

Question 3

In the IS-LM model when taxation increases, in short-run equilibrium, the interest rate ______ and output ______.

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

Answer 3

falls; falls

Question 4

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 5

Use the following to answer questions :
Exhibit: IS-LM Fiscal Policy
(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, Y₂
B) r₃, Y₂
C) r₂, Y₃
D) r₃, Y₃

Question 6

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 7

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 8

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 9

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 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

Use the following to answer questions :
Exhibit: IS-LM Fiscal Policy
(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 12

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 equilibrium level of the interest rate and output.

Question 13

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) increase; increase; increase; increase
C) decrease; decrease; increase; increase
D) increase; increase; decrease; decrease

Question 14

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 15

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 16

The increase in income in response to a fiscal expansion in the IS-LM 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 17

Use the following to answer questions :
Exhibit: IS-LM Monetary Policy
(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, Y₂
B) r₃, Y₂
C) r₂, Y₃
D) r₃, Y₃

Question 18

In the IS-LM model when government spending 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 19

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 20

Use the following to answer questions :
Exhibit: IS-LM Monetary Policy
(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 21

According to the macroeconometric model developed by Data Resources Incorporated, if taxes are increased by $100 billion, but the money supply is held constant, then GDP will fall by about:

A) zero.
B) $25 billion.
C) $75 billion.
D) $100 billion.

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

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 24

Use the following to answer questions :
Exhibit: Policy Interaction
(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 Federal Reserve should _____ the money supply shifting to _____.

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

Question 25

Use the following to answer questions :
Exhibit: Policy Interaction
(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 Federal Reserve 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 26

Use the following to answer questions :
Exhibit: Policy Interaction
(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 Federal Reserve should _____ the money supply shifting to _____.

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

Question 27

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 28

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 29

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 30

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 31

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 32

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 33

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 34

The U.S. recession of 2001 can be explained in part by a declining stock market and terrorist attacks. 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 35

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

Question 36

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 37

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.

Question 38

According to the macroeconometric model developed by Data Resources Incorporated, the response of GDP four quarters after an increase in government spending, with the nominal interest rate held constant, will be ______ the response of GDP to a similar change with the money supply held constant.

A) less than half as great as
B) approximately equal to
C) more than two times as great as
D) more than three times as great as

Question 39

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 40

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 41

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 42

Use the following to answer questions :
Exhibit: IS-LM to Aggregate Demand
(Exhibit: IS-LM to Aggregate Demand) Based on the graph, if LM₃ shifts to LM₂ because the money supply decreases from M₃ to M₂ then, holding other factors constant:

A) the aggregate demand curve will shift to the right.
B) the aggregate demand curve will shift to the left.
C) this represents a movement up the aggregate demand curve.
D) this represents a movement down the aggregate demand curve.

Question 43

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 44

If the short-run IS-LM equilibrium occurs at a level of income above the natural level of output, in the long run the ______ will ______ in order to return output to the natural level.

A) price level; increase
B) interest rate; decrease
C) money supply; increase
D) consumption function; decrease

Question 45

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 46

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 47

A tax cut shifts the ______ 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 48

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 49

Use the following to answer questions :
Exhibit: Short Run to Long Run
(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 50

Use the following to answer questions :
Exhibit: Short Run to Long Run
(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 51

When bond traders for the Federal Reserve seek to increase interest rates, they ______ bonds, which shifts the ______ curve to the left.

A) buy; IS
B) buy; LM
C) sell; IS
D) sell; LM

Question 52

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 53

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 54

One policy response to the U.S. economic slowdown of 2001 was tax cuts. 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 55

Use the following to answer questions :
Exhibit: IS-LM to Aggregate Demand
(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 56

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 57

A change in income in the IS-LM model for a fixed price

A) represents a shift in the aggregate demand curve.
B) represents a movement along the aggregate demand curve.
C) has the same effect on the aggregate demand curve as a change in income in the IS-LM model resulting from a change in the price level.
D) does not represent a change in the aggregate demand curve.

Question 58

Use the following to answer questions :
Exhibit: IS-LM to Aggregate Demand
(Exhibit: IS-LM to Aggregate Demand) Based on the graph, if LM₁ shifts to LM₂ because the price level decreases from P₁ to P₂ then, holding other factors constant:

A) the aggregate demand curve will shift to the right.
B) the aggregate demand curve will shift to the left.
C) this represents a movement up the aggregate demand curve.
D) this represents a movement down the aggregate demand curve.

Question 59

When bond traders for the Federal Reserve seek to decrease interest rates, they ______ bonds, which shifts the ______ curve to the right.

A) buy; IS
B) buy; LM
C) sell; IS
D) sell; LM

Question 60

One policy response to the U.S. economic slowdown of 2001 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 61

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 result in higher income and:

A) higher interest rates.
B) lower interest rates.
C) no change in interest rates.
D) either higher, lower, or unchanging interest rates.

Question 62

The spending 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 63

The Great Depression in the United States:

A) probably was caused by a rightward shift in the LM curve because the price level fell more rapidly than the fall in the money supply from 1929 to 1933.
B) cannot be attributed to a fall in the money supply because the money supply did not fall.
C) probably cannot be considered to have started because of a leftward shift in the LM curve because real balances did not fall between 1929 and 1931.
D) probably was caused by a leftward shift in the LM curve because interest rates remained high between 1929 and 1933.

Question 64

The Pigou effect:

A) suggests that as prices fall and real money balances rise, consumers should feel less wealthy and spend less.
B) suggests that as prices fall and real money balances rise, consumers should feel wealthier and spend more.
C) suggests that as prices fall and real money balances rise, consumers should feel less wealthy but spend more.
D) is generally accepted as adequate proof that the economy must be able to correct itself.

Question 65

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 66

An unexpected deflation can change demand by redistributing wealth from:

A) creditors to debtors, thus raising consumption.
B) creditors to debtors, thus lowering consumption.
C) debtors to creditors, thus lowering consumption.
D) debtors to creditors, thus raising consumption.

Question 67

Analysis of the short and long runs indicates that the ______ assumptions are most appropriate in ______.

A) classical; both the short and long runs.
B) Keynesian; both the short and long runs.
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 68

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

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

Question 69

The macroeconomic model may be completed by adding either the Keynesian assumption that ______ or the classical assumption that ______.

A) output is fixed; prices are fixed
B) prices are fixed; output is fixed
C) the interest rate is fixed; the money supply is fixed
D) prices are flexible; output varies

Question 70

All of the following events are consistent with the spending hypothesis as contributing to the Great Depression except:

A) the decline in investment spending on housing because of a decline in immigration in the 1930s.
B) the decline in consumption spending caused by the stock market crash of 1929.
C) fiscal policy to reduce the budget deficit by raising taxes in 1932.
D) the 25-percent reduction in the money supply between 1929 and 1933.

Question 71

In the IS-LM model, starting with no 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 72

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 73

In the IS-LM model, a decrease in expected inflation (or an increase in expected deflation), leads to a(n):

A) increase in both output and the nominal interest rate.
B) decrease in both output and the nominal interest rate.
C) increase in output and a decrease in the nominal interest rate.
D) decrease in output and an increase in the nominal interest rate.

Question 74

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 75

Possible explanations put forth for the Great Depression do not include:

A) a shift in the IS curve.
B) a shift in the LM curve.
C) the debt-deflation theory.
D) the Pigou effect.

Question 76

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 77

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 78

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 79

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 80

During the financial crisis of 2008-2009, many financial institutions stopped making 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.