Deck 11: 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 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.

Answer 2

unplanned inventory investment is negative.

Question 3

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

Answer 3

national income; goods and services

Question 4

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 5

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

Question 6

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 7

When drawn on a graph with Y along the horizontal axis and PE along the vertical axis, the line showing planned expenditure 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 8

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 9

A 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 10

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 11

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

Question 12

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 13

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 14

Use the following to answer questions :
Exhibit: Keynesian Cross
(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 15

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 16

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

Question 17

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 18

Use the following to answer questions :
Exhibit: Keynesian Cross
(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

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

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

Question 20

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 21

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 22

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 23

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 24

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) $0.75 billion; more than $0.75 billion
C) $0.75 billion; $0.75 billion
D) $1 billion; $1 billion

Question 25

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 26

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) $0.75 billion; more than $0.75 billion
C) $0.75 billion; $0.75 billion
D) $1 billion; $1 billion

Question 27

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 28

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 29

In the Keynesian-cross model, fiscal policy has a multiplied 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 30

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 31

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 32

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 33

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 34

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 35

According to the Keynesian-cross analysis, when there is a shift upward in the government-purchases schedule by an amount $\Delta$ G and the planned expenditure schedule by an equal amount, then equilibrium income rises by:

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

Question 36

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 37

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

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

Question 38

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 39

Use the following to answer questions :
Exhibit: Keynesian Cross
(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 40

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 41

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 42

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 43

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 44

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 45

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 46

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 47

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 48

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 49

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 50

Changes in fiscal policy shift the:

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

Question 51

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 52

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 53

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

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

Question 54

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 55

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 56

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 57

One argument in favor 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 58

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 59

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 60

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 61

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 62

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 63

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 64

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 65

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 66

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 67

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 68

Use the following to answer questions :
Exhibit: Market for Real Money Balances
(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 69

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 70

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 71

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 72

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 73

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 74

Use the following to answer questions :
Exhibit: Market for Real Money Balances
(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 75

Reducing the money supply ______ nominal interest rates in the short run, and ______ nominal interest rates in the long run.

A) produces no change in; raises
B) raises; produces no change in
C) raises; lowers
D) lowers; raises

Question 76

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 77

Use the following to answer questions :
Exhibit: Market for Real Money Balances
(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 78

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 79

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 80

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.