Chapter 9 Mishkin

Macreconomics: Policy and Practice (Mishkin)
Chapter 9 The IS Curve

9.1 Planned Expenditure
1) There are no questions for this section.
Answer:
9.2 The Components of Expenditure
1) Total areate demand includes !!!!!!!!.
A) planned in"estment spendin
#) consumption expenditures
C) net exports
$) all of the a%o"e
E) none of the a%o"e
Answer: $
Topic: 9.1 The Components of Expenditure
2) The consumption function shows how !!!!!!!!.
A) the marinal propensit& to consume "aries with disposa%le income
#) income "aries as a result of chanes in consumption
C) consumption depends on the decision to sa"e
$) all of the a%o"e
Answer: E
') Consumption expenditures decrease when !!!!!!!!.
A) the real interest rate falls
#) disposa%le income increases
C) autonomous consumption increases
$) all of the a%o"e
Answer: E
AAC(#: )eflecti"e Thin*in
+) ,f disposa%le income falls- consumption expenditure falls !!!!!!!!.
A) %& an amount that depends on the real interest rate
#) so that planned expenditure remains constant
C) %& an amount smaller than the decrease in disposa%le income
$) all of the a%o"e
Answer: C
1
Cop&riht . 2/12 Pearson Education- ,nc.
0) Total planned expenditure 1equals total output) is 1+-/// when autonomous consumption
expenditure is +0/. 2hen autonomous consumption expenditure falls to +//- total planned
expenditure 1equals total output) is 1'-3//. The marinal propensit& to consume is !!!!!!!!.
A) /.39
#) /.40
C) /.99
$) /.++
E) /./'
Answer: #
AAC(#: Anal&tical (*ills
5) Total planned expenditure 1equals income) is 1'-0//- autonomous consumption expenditure is
5//- the marinal propensit& to consume is /.3- o"ernment purchases are 2-4//- taxes are 2-0//
and planned in"estment spendin is 2-9//. 6et exports is !!!!!!!!.
A) '-3+/
#) neati"e 1-0//
C) neati"e 1-'3/
$) neati"e 1-'+/
E) 2-1//
Answer: #
4) Consumption expenditure is 10-///- o"ernment purchases are 0-///- planned in"estment
spendin is +-/// and net exports are 1-0//. ,f total output is 20-///- then unplanned in"entor&
in"estment is !!!!!!!!.
A) neati"e 0//
#) 2-0//
C) '-0//
$) +-///
E) neati"e +0/
Answer: A
3) An increase in the real interest rate will cause an increase in !!!!!!!!.
A) sa"in
#) planned in"estment
C) net exports
$) all of the a%o"e
Answer: A
2
9) An decrease in the real interest rate will cause an increase in !!!!!!!!.
A) consumption
#) planned in"estment
C) net exports
$) all of the a%o"e
Answer: $
1/) 2hen firms spend more on additional holdins of raw materials- parts and finished oods
!!!!!!!!.
A) the& are increasin their fixed in"estment
#) the& are increasin their in"entor& in"estment
C) the& are increasin their pri"ate consumption
$) all of the a%o"e
Answer: #
11) 7ixed in"estment is t&picall& !!!!!!!!.
A) smaller than in"entor& in"estment
#) calculated as the chane in holdins of raw materials and finished oods
C) planned spendin on equipment- structures- and new residential housin
$) all of the a%o"e
Answer: C
12) Planned in"estment spendin !!!!!!!!.
A) is equal to planned fix in"estment spendin plus the amount of in"entor& in"estment planned
%& firms
#) is closel& related to the real interest rate
C) is hea"il& influenced %& expectations a%out the future
$) all of the a%o"e
Answer: $
1') Planned in"estment spendin !!!!!!!!.
A) is equal to planned fixed in"estment spendin plus o"ernment in"estment
#) is unrelated to the real interest rate
C) is hea"il& influenced %& expectations a%out the future
$) all of the a%o"e
Answer: C
'
1+) ,n"estment spendin !!!!!!!!.
A) is comprised of fixed and in"entor& in"estment
#) is neati"el& related to the real interest rate
C) is hea"il& influenced %& what 8e&nes coined as 9animal spirits9
$) all of the a%o"e
Answer: $
10) 2hen the :.(. real interest rate falls !!!!!!!!.
A) :.(. dollar assets earn a hiher return relati"e to forein assets
#) it ma*es :.(. exports more expensi"e in forein currencies
C) imports will decrease
$) all of the a%o"e
Answer: C
15) 2hen the :.(. real interest rate rises !!!!!!!!.
A) :.(. dollar assets earn a lower return relati"e to forein assets
#) ma*es :.(. exports more expensi"e in forein currencies
$) all of the a%o"e
Answer: #
14) 2hen the :.(. real interest rate rises !!!!!!!!.
A) :.(. dollar assets earn a hiher return relati"e to forein assets
#) ma*es :.(. exports cheaper in forein currencies
$) all of the a%o"e
Answer: A
+
13) 6et exports !!!!!!!!.
A) are hea"il& determined %& forein demand for domestic oods
#) are hea"il& determined %& domestic demand for domestic oods
C) are independent of domestic interest rate fluctuations
$) all of the a%o"e
Answer: A
19) Planned expenditures !!!!!!!!.
A) are directl& affected %& o"ernment purchases
#) increase when there is a reduction in taxes
C) decrease when disposa%le income decreases
$) all of the a%o"e
Answer: $
2/) 2hat is the meanin of 9animal spirits9; <ow do these relate to planned in"estment spendin
and to unplanned in"estment spendin;
Answer: Animal spirits are emotional wa"es of optimism and pessimism. The& influence
autonomous in"estment- chanin the amount of planned in"estment at an& real interest rate.
The& impact unplanned in"estment- as well- since each firm=s planned in"estment expenditures
are- t&picall&- purchases from other firms. A sudden chane from optimism to pessimism will
lea"e %usinesses with unsold in"entor&- an increase in in"entor& in"estment. :nplanned neati"e
in"entor& in"estment results from a chane from pessimism to optimism.
21) The in"estment function implies that current output does not influence in"estment. $oes that
ma*e sense;
Answer: >es. Planned in"estment relies mostl& on %usiness expectations of future economic
acti"it&. 7luctuations in current acti"it& affect in"estment as unplanned in"entor& chanes and-
perhaps- as an updatin of expectations- causin a chane in autonomous in"estment.
0
22) Acme #rands in"ested ?0 million in 2/1/ on new equipment- spent ?40/ thousand to
increase its in"entor& of intermediate components- and added ?20 thousand to its in"entor& of
finished oods. At &ear=s end- the components in"entor& is found to %e ?2// thousand a%o"e its
%einnin@of@the@ &ear le"el- and finished oods in"entor& is up ?'/ thousand o"er its startin
le"el. Calculate planned in"estment- unplanned in"estment- and actual 1total) in"estment.
Answer: Planned in"estment is ?0 million plus ?40/ thousand plus ?20 thousand equals ?0.440
million. :nplanned in"estment is ?2// thousand minus ?40/ thousand plus ?'/ thousand minus
?20 thousand equals neati"e ?0+0 thousand. Actual in"estment is ?0 million plus ?2// thousand
plus ?'/ thousand equals ?0.2' million 1equals ?0.440 million minus ?0+0 thousand).
9.' Aoods Bar*et Equili%rium
1) The ,( cur"e !!!!!!!!.
A) shows the relationship %etween areate output and the real interest rate when the oods
mar*et is in equili%rium
#) tells us that increases in autonomous consumption- in"estment- o"ernment purchases- or net
exports raise output for an& real interest rate
C) tells us that a decrease in taxes leads to increases in output for an& i"en real interest rate
$) all of the a%o"e
Answer: $
Topic: 9.2 Aoods Bar*et Equili%rium
2) ,n the ,( cur"e !!!!!!!!.
A) an increase in the interest rate constitutes an upward mo"ement alon the cur"e
#) an increase in areate consumption constitutes a downward mo"ement alon the cur"e
C) an increase in taxes constitutes a rihtward shift of the cur"e
$) all of the a%o"e
Answer: A
') The ,( cur"e !!!!!!!!.
A) traces out the points at which the oods mar*et is in equili%rium
#) tells us how consumption expenditures fall as the real interest rises
C) tells us that as the real interest rate rises planned expenditures o down leadin to increases in
sa"ins that satisf& the oods mar*et equili%rium
$) all of the a%o"e
Answer: $
5
+) ,f areate output is %elow its equili%rium le"el !!!!!!!!.
A) there is an excess demand for oods
#) actual output is %elow planned expenditure
C) firms will tend to replenish their low in"entories dri"in output up toward equili%rium
$) all of the a%o"e
Answer: $
0) ,f areate output is a%o"e its equili%rium le"el !!!!!!!!.
A) there is an excess suppl& of oods
#) actual output is %elow planned expenditure
C) firms will tend to replenish their low in"entories dri"in output up toward equili%rium
$) all of the a%o"e
Answer: A
5) ,n the ,( cur"e- if > falls for an& i"en le"el of the real interest rate !!!!!!!!.
A) consumption decreases
#) output increases
C) sa"in increases
$) all of the a%o"e
Answer: A
4) ,n the ,( cur"e- if > increases for an& i"en le"el of the real interest rate !!!!!!!!.
A) consumption increases
#) output decreases
C) sa"in decreases
$) all of the a%o"e
Answer: A
4
3) ,n the ,( cur"e- if > falls for an& i"en le"el of the real interest rate !!!!!!!!.
A) consumption increases
#) output increases
C) sa"in increases
$) all of the a%o"e
Answer: E
9) ,n the ,( cur"e- a cut in taxes !!!!!!!!.
A) causes planned expenditures and hence equili%rium output to rise when the interest rate
increases
#) causes planned expenditures and hence equili%rium output to fall when the interest rate
increases
C) causes the equili%rium interest rates to fall
$) all of the a%o"e
Answer: E
1/) The reason for the downward@slopin ,( cur"e is that !!!!!!!!.
A) lower interest rates lead to lower sa"in and lower output
#) lower interest rates lead to lower sa"in and hiher output
C) hiher interest rates lead to lower sa"in and hiher output
$) all of the a%o"e
Answer: #
11) The reason for the downward@slopin ,( cur"e is that !!!!!!!!.
A) lower interest rates lead to hiher sa"in and hiher output
#) hiher interest rates lead to hiher sa"in and lower output
C) hiher interest rates lead to lower sa"in and hiher output
$) all of the a%o"e
Answer: #
3
IS Curve Exogenous Variables and Parameters
Table
C 2
mp! " #$%&
C '
! " #$#&
C 1.+0
d " #$'
C 1.5
x " #$&
C 1
12) Ai"en the "alues in the ta%le a%o"e- the ,( cur"e is !!!!!!!!.
A) > C '+.5 @ 2r
#) > C 3.50 @ 2r
C) > C 20 @ 2r
$) > C 3.'' @ /.54r
Answer: C
1') Ai"en the "alues in the ta%le a%o"e- equili%rium output > C !!!!!!!! when the real interest
rate r C +.
A) 25.5
#) /.50
C) 14
$) 0.50
Answer: C
1+) Ai"en the "alues in the ta%le a%o"e- the real interest rate r C !!!!!!!! when equili%rium
output > C 10.
A) 9.3
#) 0
C) '.13
$) 1/
Answer: #
9
10) Ai"en the "alues in the ta%le a%o"e- consumption is !!!!!!!! when equili%rium output is
10.
A) 12.'
#) 11.3
C) 12./0
$) 11.00
Answer: #
15) Ai"en the "alues in the ta%le a%o"e- if the real interest rate rises from 0 to 5- the chane in
household sa"in is !!!!!!!!.
A) neati"e /.0
#) neati"e 1.00
C) neati"e /.+0
$) 1.00
Answer: C
IS (raph
14) Dn the raph a%o"e- output is a%o"e planned expenditures at point !!!!!!!!.
A) A
#) #
C) A
$) <
Answer: C
1/
13) Dn the raph a%o"e- assumin that A C / and 6E C /- sa"in is a%o"e planned in"estment at
point !!!!!!!!.
A) A
#) #
C) A
$) <
Answer: C
19) Dn the raph a%o"e- unplanned in"entor& in"estment is neati"e at point !!!!!!!!.
A) A
#) #
C) A
$) <
Answer: $
2/) Dn the raph a%o"e- the la%eled point at which in"estment @@ planned plus unplanned @@ is
hihest is point !!!!!!!!.
A) A
#) #
C) A
$) <
E) not infera%le from the information i"en
Answer: #
21) Dn the raph a%o"e- assumin that A C / and 6E C /- the la%eled point at which sa"in is
lowest is point !!!!!!!!.
A) A
#) #
C) A
$) <
E) not infera%le from the information i"en
Answer: E
11
22) ,f planned expenditure is %elow output- as the econom& approaches equili%rium- !!!!!!!!.
A) planned expenditure is fallin
#) output is risin
C) sa"in is risin
$) all of the a%o"e
Answer: A
2') ,f planned expenditure is %elow output- as the econom& approaches equili%rium- !!!!!!!!.
A) planned expenditure is risin
#) output is risin
C) sa"in is risin
$) all of the a%o"e
Answer: E
IS Curve Exogenous Variables and Parameters
Table )
C '
mp! " #$*
C 0
! " #$#+
C 2
d " #$,
C 2
x " #$
C 1
2+) :sin the "alues in the ta%le a%o"e- and assumin that the real interest rate equals +-
calculate equili%rium "alues for consumption- household sa"in- in"estment- and net exports.
:se these "alues to confirm that the oods mar*et is in equili%rium.
Answer: Enterin the i"en "alues in the ,( cur"e equation &ields > C 13.4. Pluin > and r
into the consumption equation &ields C C 12.4. (u%tractin C F T from > i"es household sa"in
C +. The in"estment equation usin these "alues of > and r &ields , C '.+. The net exports
equation &ields 6E C /.5. 6ote that ( C 6E F , @ 1A @ T)- so the oods mar*et is in equili%rium.
Also- > C C F , F A F 6E- so the oods mar*et is in equili%rium.
12
20) ,n the text- the equi"alence of the oods mar*et equili%rium in the ,( model to the
equili%rium in which desired in"estment equals desired sa"in is demonstrated- assumin that
%oth o"ernment purchases and net exports are Gero. $emonstrate the equi"alence when %oth A
and 6E are non@Gero.
Answer: ,n terms of output and expenditures- the equili%rium condition is > C C F , F A F 6E.
)earranin terms- > @ C @ A C , F 6E. 7or households- sa"in is > @ T @ C. Ao"ernment sa"in
is T @ A. 6ational sa"in ( C > @ T @ C F T @ A C > @ C @ A. (u%stitutin into the equili%rium
equation- ( C , F 6E. 6ow- the com%ined sa"in %& households and the o"ernment ma& %e
reater or less than in"estment- with the difference made up %& a capital outflow 16E H /) or
capital inflow 16E I /)- respecti"el&.
9.+ :nderstandin the ,( Cur"e
1) There are no questions for this section.
Answer:
9.0 7actors that (hift the ,( Cur"e
1) The ,( cur"e !!!!!!!! when the real interest rate increases.
A) shifts to the riht
#) shifts to the left
C) shifts up
$) all of the a%o"e
Answer: E
Topic: 9.' 7actors that shift the ,( Cur"e
2) The ,( cur"e !!!!!!!!.
A) shifts to the riht when autonomous consumption increases
#) shifts up when the real interest rate increases
C) shifts to the left when autonomous in"estment increases
$) all of the a%o"e
Answer: A
1'
') The ,( cur"e shifts to the left when !!!!!!!!.
A) autonomous consumption increases
#) taxes increase
C) autonomous in"estment increases
$) all of the a%o"e
Answer: #
+) The ,( cur"e shifts to the left when !!!!!!!!.
A) autonomous consumption increases
#) taxes decrease
C) autonomous in"estment decreases
$) all of the a%o"e
Answer: C
0) The ,( cur"e shifts to the riht when !!!!!!!!.
A) autonomous consumption decreases
#) taxes increase
C) autonomous in"estment increases
$) all of the a%o"e
Answer: C
5) ,f the o"ernment increases militar& spendin !!!!!!!!.
A) the ,( cur"e would shift to the left
#) output will decrease if interest rates remain fixed
C) the unemplo&ment rate could fall
$) all of the a%o"e
Answer: C
1+
4) ,f the o"ernment reduces spendin !!!!!!!!.
A) the ,( cur"e will shift to the riht
#) output will increase if interest rates remain fixed
C) consumption will increase
$) all of the a%o"e
Answer: E
3) ,f the o"ernment raises taxes !!!!!!!!.
A) planned expenditures fall
#) equili%rium output falls
C) the ,( cur"e shifts to the left
$) all of the a%o"e
Answer: $
9) ,f the o"ernment cuts taxes !!!!!!!!.
A) disposa%le income falls
#) planned expenditures rise
C) the ,( cur"e shifts to the left
$) all of the a%o"e
Answer: #
1/) The 2//9 fiscal stimulus pac*ae was passed !!!!!!!!.
A) to pre"ent the real interest rate from risin
#) to shift the ,( cur"e to the left
C) to raise areate output at an& interest rate
$) all of the a%o"e
Answer: C
10
11) The 2//9 fiscal stimulus pac*ae did not wor* !!!!!!!!.
A) in that the ,( cur"e did not shift to the riht
#) %ecause most of the intended increase in o"ernment spendin too* too lon to *ic* in
C) %ecause the increase in o"ernment spendin was not enouh to offset the decline in
autonomous expenditure
$) all of the a%o"e
Answer: $
12) The 2//9 fiscal stimulus pac*ae did not wor* !!!!!!!!.
A) %ecause risin interest rates nullified increased expenditures
#) %ecause o"ernment spendin rose too quic*l& and too %riefl&
C) %ut it pro%a%l& pre"ented the ,( cur"e from shiftin further to the left
$) all of the a%o"e
Answer: C
1') Jualitati"el&- an increase in o"ernment purchases has the same impact as an increase in
autonomous !!!!!!!!.
A) consumption
#) in"estment
C) net exports
$) all of the a%o"e
Answer: $
1+) ,n the ,( model- assumin that the real interest rate does not chane- an increase in
autonomous !!!!!!!! leads to an increase in the equili%rium le"el of !!!!!!!!.
A) in"estmentK consumption
#) consumptionK in"estment
C) net exportsK in"estment
$) all of the a%o"e
Answer: A
15
10) ,n the ,( model- assumin that the real interest rate does not chane- an increase in
autonomous !!!!!!!! leads to an increase in the equili%rium le"el of !!!!!!!!.
A) in"estmentK net exports
#) consumptionK o"ernment purchases
C) net exportsK taxes
$) all of the a%o"e
Answer: E
autonomous net exports causes total in"estment- planned plus unplanned- to !!!!!!!!.
A) fall- then rise %ac* to its initial le"el
#) fall- then rise a%o"e its initial le"el
C) rise- then fall %ac* to its initial le"el
$) all of the a%o"e
Answer: A
14) ,n the ,( model- assumin that the real interest rate does not chane- an increase in !!!!!!!!
leads to an increase in equili%rium sa"in %& households.
A) autonomous in"estment
#) o"ernment purchases
C) autonomous net exports
$) all of the a%o"e
Answer: $
13) ,n the ,( model- assumin that the real interest rate does not chane- an increase in !!!!!!!!
leads to an increase in equili%rium sa"in %& households.
A) autonomous consumption
#) taxes
C) the price le"el
$) all of the a%o"e
Answer: E
14
autonomous !!!!!!!! leads to a decrease in equili%rium sa"in.
A) in"estment
#) consumption
C) net exports
$) all of the a%o"e
Answer: E
2/) An increase in autonomous consumption !!!!!!!!.
A) lowers planned expenditures
#) raises equili%rium output for an& le"el of the interest rate
C) causes a mo"ement down alon the ,( cur"e
$) all of the a%o"e
Answer: #
21) A decrease in autonomous consumption !!!!!!!!.
A) lowers planned expenditures
#) raises equili%rium output for an& le"el of the interest rate
C) causes a mo"ement down alon the ,( cur"e
$) all of the a%o"e
Answer: A
22) A decrease in autonomous consumption !!!!!!!!.
A) raises planned expenditures
#) lowers equili%rium output for an& le"el of the interest rate
C) shifts the ,( cur"e to the riht
$) all of the a%o"e
Answer: #
13
2') An increase in autonomous in"estment !!!!!!!!.
A) increases equili%rium output at an& interest rate
#) causes a mo"ement down alon the ,( cur"e
C) shifts the ,( cur"e to the left
$) all of the a%o"e
Answer: A
2+) A decrease in autonomous in"estment !!!!!!!!.
A) increases equili%rium output at an& interest rate
#) causes a mo"ement down alon the ,( cur"e
$) all of the a%o"e
Answer: C
20) A decrease in autonomous in"estment !!!!!!!!.
A) decreases equili%rium output at an& interest rate
#) lowers planned expenditures
$) all of the a%o"e
Answer: $
25) ,f people feel optimistic a%out the future of the econom& !!!!!!!!.
A) autonomous consumption miht increase
#) autonomous in"estment miht increase
C) it miht shift the ,( cur"e to the riht
$) all of the a%o"e
Answer: $
19
24) ,n a stoc* mar*et %oom !!!!!!!!.
A) autonomous consumption miht increase %ecause stoc* holders miht feel richer and
consume more
#) autonomous in"estment miht increase %ecause a hiher stoc* "alue for a firm helps firms
raise funds for increased in"estment
C) the ,( cur"e miht shift to the riht
$) all of the a%o"e
Answer: $
23) ,n a stoc* mar*et %oom !!!!!!!!.
A) o"ernment spendin will decrease
#) interest rates will decrease
C) sa"in is li*el& to decrease
$) all of the a%o"e
Answer: E
2/
IS (raph )
29) Dn the raph a%o"e- a possi%le cause of the rihtward shift of the ,( cur"e is an increase in
!!!!!!!!.
A) forein demand for domestic oods
#) taxes
C) domestic demand for forein oods
$) the exchane rate
Answer: A
'/) Dn the raph a%o"e- unplanned in"entor& in"estment occurs if the econom& is mo"in from
point !!!!!!!! to point !!!!!!!!.
A) $K C
#) CK #
C) #K A
$) all of the a%o"e
Answer: $
21
'1) Dn the raph a%o"e- the amount of in"entor& depletion will %e reatest if the econom& is
mo"in from point !!!!!!!! to point !!!!!!!!.
A) AK $
#) $K A
C) $K C
$) #K A
E) #K C
Answer: A
'2) Dn the raph a%o"e- if the econom& is at point A when the real interest rate falls- the
econom&=s new situation miht %e indicated %& point !!!!!!!!.
A) A
#) #
C) C
$) $
Answer: #
'') Dn the raph a%o"e- if the :.(. econom& is at point # in 2//9- then the econom& in 2/1/ is
%est represented %& point !!!!!!!!.
A) A
#) #
C) C
$) $
E) an& of the la%eled points is as ood as the others
Answer: #
'+) )eferrin to the raph a%o"e- assume that the econom& is in equili%rium at point A- then an
22
increase in o"ernment purchases shifts the ,( cur"e to the riht- while the real interest rate
remains constant. Explain- step@%&@step- how the components of expenditure adLust to %rin the
econom& to its new equili%rium.
Answer: The increase in A causes neati"e unplanned in"entor& in"estment- so firms respond %&
increasin output. As output rises- consumption rises- so in"entories continue to shrin* and
output continues to rise. The increase in consumption is alwa&s a fraction of the increase in
output- %ecause the marinal propensit& to consume is less than one. The increase in
consumption- the decline in in"entories- and the increase in output all con"ere to Gero as the
econom& approaches its new equili%rium at point C.
'0) Assume that households decide to sa"e more- so autonomous consumption is reduced.
Explain- step@%&@step- how the components of expenditure adLust to %rin the econom& to its new
equili%rium. :sin the ,( cur"e equation and the consumption function- compare the initial and
new equili%ria with respect to sa"in and the real interest rate.
Answer: Consumption is reduced- so there is unplanned in"entor& in"estment that sinals firms
to reduce output. $eclinin output causes consumption to decline furtherK unplanned in"entor&
in"estment continues and output continues to fall. The decline in consumption is continuall&
shrin*in- since households respond to reductions in disposa%le income %& reducin sa"in- as
well as reducin consumption 1the marinal propensit& to consume is less than one). 2hen the
decrease in consumption con"eres to Gero- in"entories stop risin and output stops fallin. The
decline in output > C . The chane in consumption C C F mpc M
( ) >
@ c M r.
(u%stitutin the first of these equations into the second- simplif&in- then su%stitutin with the
first equation aain- re"eals that C C > @ c M r. ,f the real interest rate does not chane- then
sa"in in the new equili%rium equals the oriinal sa"in in the old equili%rium 1since output has
fallen %& the same amount as consumption). And- if sa"in has not chaned- then neither has the
real interest rate chaned.
'5) Assume that the econom& is in equili%rium when the real interest rate rises. Explain- step@%&@
step- how the components of expenditure adLust to %rin the econom& to its new equili%rium.
Answer: An increase in the real interest rate reduces consumption- in"estment- and net exports.
)educed expenditures cause an unplanned in"entor& adLustment to which firms respond %&
reducin output. The econom& is mo"in to the left alon the ,( cur"e. The slope of the ,( cur"e
reflects the further output declines that occur as consumption falls in response to declinin
output- until the chane in consumption has con"ered to Gero 1the marinal propensit& to
consume is less than one).
2'
'4) The ,( model implies that a dollar of o"ernment spendin has a larer impact on
equili%rium output than does a dollar of taxes. Explain.
Answer: ,n the ,( equation- o"ernment purchases are a component of autonomous spendin- no
different than autonomous consumption- in"estment- and net exports. 7rom the perspecti"e of
producers- a customer is a customer. Taxes- clearl&- are not an expenditure. Taxes affect
expenditure %& reducin disposa%le income and- thus- consumption. (ince onl& a fraction of
disposa%le income is spent for consumption @@ a fraction measured as the marinal propensit& to
consume @@ each dollar of taxes corresponds to a fraction of a dollar ta*en from consumption
expenditure.
'3) 7or simplicit&- the ,( model assumes that neither net exports nor net taxes "ar& with income.
A more realistic 1and complicated) model would drop such assumptions. <ow would the
%eha"ior of the ,( cur"e differ in the more realistic model;
Answer: ,n a more realistic model- increases in income would result in %oth more imports %ein
purchased and more taxes %ein paid. The purchase of imports instead of domestic output lessens
the impact of expenditure chanes on in"entories and- thus- on equili%rium output. (hifts of the
,( cur"e in response to chanes in autonomous spendin would %e smaller. Taxes that rise with
income reduce the siGe of chanes in consumption spendin in response to output chanes- so
aain shifts of the ,( cur"e are smaller. Chanes in the real interest rate chane expenditures- %ut
the effect on output is reduced to the extent that imports and taxes are chanin- so the more
realistic ,( cur"e is steeper than the cur"e in the text.
2+

Chapter 9 Mishkin

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Macreconomics: Policy and Practice (Mishkin)

Chapter 9 The IS Curve

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