You are on page 1of 40

Pool Canvas

1 of 40

http://cp03.coursecompass.com/webapps/assessment/do/authoring/view...

COURSES > ACCE > CONTROL PANEL > POOL MANAGER > POOL CANVAS

Pool Canvas
Add, modify, and remove questions. Select a question type from the Add Question drop-down list and click Go to add questions. Use
Creation Settings to establish which default options, such as feedback and images, are available for question creation.
Add

Creation Settings
Testbank Chapter 11: Aggregate Demand II

Name

Description Question pool for Testbank Chapter 11: Aggregate Demand II


Instructions
Add Question Here
Multiple Choice

0 points

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

the price level and the inflation rate.


the interest rate and the price level.
investment and the money supply.
the interest rate and the level of output.
Add Question Here

Multiple Choice

0 points

Question
Exhibit: IS-LM Fiscal Policy

Reference: Ref 11-1

(Exhibit: IS-LM Fiscal Policy) Based on the graph, starting from equilibrium at interest rate r and income
1

Y1, a decrease in government spending would generate the new equilibrium combination of interest rate
and income:
Answer

r2, Y2
r3, Y2
r2, Y3

6/1/2012 8:51 PM

Pool Canvas

http://cp03.coursecompass.com/webapps/assessment/do/authoring/view...

r3, Y3
Add Question Here
Multiple Choice

0 points

Question
Exhibit: IS-LM Fiscal Policy

Reference: Ref 11-1

(Exhibit: IS-LM Fiscal Policy) Based on the graph, starting from equilibrium at interest rate r and income
1

Y1, an increase in government spending would generate the new equilibrium combination of interest rate
and income:
Answer

r2, Y2
r3, Y2
r2, Y3
r3, Y3
Add Question Here

Multiple Choice

0 points

Question
Exhibit: IS-LM Fiscal Policy

2 of 40

6/1/2012 8:51 PM

Pool Canvas

http://cp03.coursecompass.com/webapps/assessment/do/authoring/view...

Reference: Ref 11-1

(Exhibit: IS-LM Fiscal Policy) Based on the graph, starting from equilibrium at interest rate r and income
1

Y1, a tax cut would generate the new equilibrium combination of interest rate and income:
Answer

r2, Y2
r3, Y2
r2, Y3
r3, Y3
Add Question Here

Multiple Choice

0 points

Question
In the IS-LM model when government spending rises, in short-run equilibrium, in the usual case, the
interest rate ______ and output ______.
Answer

rises; falls
rises; rises
falls; rises
falls; falls
Add Question Here

Multiple Choice

0 points

Question
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.
Answer

decrease; decrease; decrease; decrease


increases; increase; increases; increase
decrease; decrease; increase; increase
increase; increase; decrease; decrease
Add Question Here

Multiple Choice

3 of 40

0 points

6/1/2012 8:51 PM

Pool Canvas

http://cp03.coursecompass.com/webapps/assessment/do/authoring/view...

Question
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 ______.
Answer

increase; supply
increase; demand
decrease; supply
decrease; demand
Add Question Here

Multiple Choice

0 points

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

rises; falls
rises; rises
falls; rises
falls; falls
Add Question Here

Multiple Choice

0 points

Question
If the LM curve is vertical and government spending rises by G, in the IS-LM analysis, then equilibrium
income rises by:
Answer

G/(1 MPC).
more than zero but less than G/(1 MPC).

G.
zero.
Add Question Here
Multiple Choice

0 points

Question
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:
Answer

100.
200.
300.
400.
Add Question Here

Multiple Choice

0 points

Question
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:
Answer

100.
200.
300.
400.
Add Question Here

Multiple Choice

4 of 40

0 points

6/1/2012 8:51 PM

Pool Canvas

http://cp03.coursecompass.com/webapps/assessment/do/authoring/view...

Question
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:
Answer

prices.
investment.
the money supply.
taxes.
Add Question Here

Multiple Choice

0 points

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

always less than in the Keynesian-cross model.


less than in the Keynesian-cross model unless the LM curve is vertical.
less than in the Keynesian-cross model unless the LM curve is horizontal.
less than in the Keynesian-cross model unless the IS curve is vertical.
Add Question Here

Multiple Choice

0 points

Question
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.
Answer

larger than the multiplier


the same as the multiplier
smaller than the multiplier
sometimes larger and sometimes smaller than the multiplier
Add Question Here

Multiple Choice

0 points

Question
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:
Answer

investment is not affected by the interest rate whereas in the IS-LM model fiscal expansion
raises the interest rate and crowds out investment.
investment is not affected by the interest rate whereas in the IS-LM model fiscal expansion
lowers the interest rate and crowds out investment.
investment is autonomous whereas in the IS-LM model fiscal expansion encourages higher
investment, which raises the interest rate.
the price level is fixed whereas in the IS-LM model it is allowed to vary.
Add Question Here

Multiple Choice

0 points

Question
In the IS-LM model, changes in taxes initially affect planned expenditures through:
Answer

consumption.
investment.
government spending.
the interest rate.
Add Question Here

Multiple Choice

5 of 40

0 points

6/1/2012 8:51 PM

Pool Canvas

http://cp03.coursecompass.com/webapps/assessment/do/authoring/view...

Question
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.
Answer

less than
greater than
equal to
sometimes less and sometimes greater than
Add Question Here

Multiple Choice

0 points

Question
Exhibit: IS-LM Monetary Policy

Reference: Ref 11-2

(Exhibit: IS-LM Monetary Policy) Based on the graph, starting from equilibrium at interest rate r and income
1

Y1, a decrease in the money supply would generate the new equilibrium combination of interest rate and
income:
Answer

r2, Y2
r3, Y2
r2, Y3
r3, Y3
Add Question Here

Multiple Choice

0 points

Question
Exhibit: IS-LM Monetary Policy

6 of 40

6/1/2012 8:51 PM

Pool Canvas

http://cp03.coursecompass.com/webapps/assessment/do/authoring/view...

Reference: Ref 11-2

(Exhibit: IS-LM Monetary Policy) Based on the graph, starting from equilibrium at interest rate r and income
1

Y1, an increase in the money supply would generate the new equilibrium combination of interest rate and
income:
Answer

r2, Y2
r3, Y2
r2, Y3
r3, Y3
Add Question Here

Multiple Choice

0 points

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

LM; left
LM; right
IS; left
IS; right
Add Question Here

Multiple Choice

0 points

Question
In the IS-LM model when M/P rises, in short-run equilibrium, in the usual case, the interest rate ______ and
output ______.
Answer

rises; falls
rises; rises
falls; rises
falls; falls
Add Question Here

Multiple Choice

7 of 40

0 points

6/1/2012 8:51 PM

Pool Canvas

http://cp03.coursecompass.com/webapps/assessment/do/authoring/view...

Question
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 ______.
Answer

rises; falls
rises; rises
falls; rises
falls; falls
Add Question Here

Multiple Choice

0 points

Question
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 ______.
Answer

rises; falls
rises; rises
falls; rises
falls; falls
Add Question Here

Multiple Choice

0 points

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

slopes up to the right.


slopes down to the right.
is horizontal.
is vertical.
Add Question Here

Multiple Choice

0 points

Question
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.
Answer

buy; rises; increase


sell; falls; decrease
sell; rises; decrease
buy; rises; decrease
Add Question Here

Multiple Choice

0 points

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

the budget deficit.


investment.
government expenditures.
taxation.
Add Question Here

Multiple Choice

8 of 40

0 points

6/1/2012 8:51 PM

Pool Canvas

http://cp03.coursecompass.com/webapps/assessment/do/authoring/view...

Question
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:
Answer

directly.
by lowering the interest rate so that investment spending increases.
by raising the interest rate so that investment spending increases.
by increasing government spending on goods and services.
Add Question Here

Multiple Choice

0 points

Question
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.
Answer

lower; lower
lower; higher
no change in; lower
no change in; higher
Add Question Here

Multiple Choice

0 points

Question
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.
Answer

increase
decrease
first increase and then decrease
first decrease and then increase
Add Question Here

Multiple Choice

0 points

Question
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.
Answer

increase
decrease
first increase and then decrease
first decrease and then increase
Add Question Here

Multiple Choice

0 points

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

both consumption and investment remain unchanged.


consumption rises but investment falls.
investment rises but consumption falls.
both consumption and investment fall.
Add Question Here

Multiple Choice

9 of 40

0 points

6/1/2012 8:51 PM

Pool Canvas

10 of 40

http://cp03.coursecompass.com/webapps/assessment/do/authoring/view...

Question
Exhibit: Policy Interaction

Reference: Ref 11-3

(Exhibit: Policy Interaction) Based on the graph, starting from equilibrium at interest rate r , incomeY , IS ,
3

and LM , if there is an increase in government spending that shifts the IS curve to IS , then in order to keep
1

the interest rate constant the Federal Reserve should ______ the money supply shifting to ______.
Answer

increase; LM

decrease; LM
increase; LM

decrease; LM

Add Question Here


Multiple Choice

0 points

Question
Exhibit: Policy Interaction

Reference: Ref 11-3

6/1/2012 8:51 PM

Pool Canvas

11 of 40

http://cp03.coursecompass.com/webapps/assessment/do/authoring/view...

(Exhibit: Policy Interaction) Based on the graph, starting from equilibrium at interest rate r , income Y , IS
3

1,

and LM , if there is an increase in government spending that shifts the IS curve to IS , then in order to keep
1

output constant the Federal Reserve should ______ the money supply shifting to ______.
Answer

increase; LM

decrease; LM
increase; LM

decrease; LM

Add Question Here


Multiple Choice

0 points

Question
Exhibit: Policy Interaction

Reference: Ref 11-3

(Exhibit: Policy Interaction) Based on the graph, starting from equilibrium at interest rate r , income Y , IS ,
3

and LM , if there is an increase in government spending that shifts the IS curve to IS and the Federal
1

Reserve does not change the money supply, the new equilibrium combination of interest and income will be
______.
Answer

r1, Y2
r2, Y3
r3, Y3
r3, Y4
Add Question Here

Multiple Choice

0 points

Question
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.
Answer

less than half as great as


approximately equal to

6/1/2012 8:51 PM

Pool Canvas

http://cp03.coursecompass.com/webapps/assessment/do/authoring/view...

more than two times as great as


more than three times as great as
Add Question Here
Multiple Choice

0 points

Question
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:
Answer

zero.
$25 billion.
$75 billion.
$100 billion.
Add Question Here

Multiple Choice

0 points

Question
An increase in investment demand for any given level of income and interest ratesdue, for example, to
more optimistic animal spiritswill, within the IS-LM framework, ______ output and ______ interest rates.
Answer

increase; lower
increase; raise
lower; lower
lower; raise
Add Question Here

Multiple Choice

0 points

Question
An increase in consumer saving for any given level of income will shift the:
Answer

LM curve upward and to the left.


LM curve downward and to the right.
IS curve downward and to the left.
IS curve upward and to the right.
Add Question Here

Multiple Choice

0 points

Question
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.
Answer

increase; lower
increase; raise
lower; lower.
lower; raise
Add Question Here

Multiple Choice

0 points

Question
In the IS-LM model, a decrease in the interest rate would be the result of a(n):
Answer

increase in the money supply.


increase in government purchases.
decrease in taxes.

12 of 40

6/1/2012 8:51 PM

Pool Canvas

13 of 40

http://cp03.coursecompass.com/webapps/assessment/do/authoring/view...

increase in money demand.


Add Question Here
Multiple Choice

0 points

Question
In the IS-LM model, a decrease in output would be the result of a(n):
Answer

decrease in taxes.
increase in the money supply.
increase in money demand.
increase in government purchases.
Add Question Here

Multiple Choice

0 points

Question
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 ______.
Answer

LM; right
LM; left
IS; right
IS; left
Add Question Here

Multiple Choice

0 points

Question
One policy response to the U.S. economic slowdown of 2001 were tax cuts. This policy response can be
represented in the IS-LM model by shifting the ______ curve to the ______.
Answer

LM; right
LM; left
IS; right
IS; left
Add Question Here

Multiple Choice

0 points

Question
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 ______.
Answer

LM; right
LM; left
IS; right
IS; left
Add Question Here

Multiple Choice

0 points

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

buy; IS
buy; LM
sell; IS

6/1/2012 8:51 PM

Pool Canvas

http://cp03.coursecompass.com/webapps/assessment/do/authoring/view...

sell; LM
Add Question Here
Multiple Choice

0 points

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

buy; IS
buy; LM
sell; IS
sell; LM
Add Question Here

Multiple Choice

0 points

Question
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:
Answer

lower; raises; reduces


higher; lowers; increases
lower; lowers; increases
higher; raises; reduces
Add Question Here

Multiple Choice

0 points

Question
An economic change that does not shift the aggregate demand curve is a change in:
Answer

the money supply.


the investment function.
the price level.
taxes.
Add Question Here

Multiple Choice

0 points

Question
A change in income in the IS-LM model for a fixed price level:
Answer

represents a shift in the aggregate demand curve.


represents a movement along the aggregate demand curve.
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.
does not represent a change in the aggregate demand curve.
Add Question Here

Multiple Choice

0 points

Question
An increase in the money supply shifts the ______ curve to the right, and the aggregate demand curve
______.
Answer

14 of 40

IS; shifts to the right


IS; does not shift
LM: shifts to the right

6/1/2012 8:51 PM

Pool Canvas

15 of 40

http://cp03.coursecompass.com/webapps/assessment/do/authoring/view...

LM; does not shift


Add Question Here
Multiple Choice

0 points

Question
A tax cut shifts the ______ to the right, and the aggregate demand curve ______.
Answer

IS; shifts to the right


IS; does not shift
LM: shifts to the right
LM; does not shift
Add Question Here

Multiple Choice

0 points

Question
A decrease in the price level shifts the ______ curve to the right, and the aggregate demand curve ______.
Answer

IS; shifts to the right


IS; does not shift
LM: shifts to the right
LM; does not shift
Add Question Here

Multiple Choice

0 points

Question
A change in income in the IS-LM model resulting from a change in the price level represents a ______
aggregate demand curve, while a change in income in the IS-LM model for a given price level represents a
______ aggregate demand curve.
Answer

movement along the; shift in the


shift in the; movement along the
vertical; horizontal
horizontal; vertical
Add Question Here

Multiple Choice

0 points

Question
Exhibit: IS-LM to Aggregate Demand

6/1/2012 8:51 PM

Pool Canvas

http://cp03.coursecompass.com/webapps/assessment/do/authoring/view...

Reference: Ref 11-4

(Exhibit: IS-LM to Aggregate Demand) Based on the graph, if LM shifts to LM because the price level
1

decreases from P to P , then, holding other factors constant:


1

Answer

the aggregate demand curve will shift to the right.


the aggregate demand curve will shift to the left.
this represents a movement up the aggregate demand curve.
this represents a movement down the aggregate demand curve.
Add Question Here

Multiple Choice

0 points

Question
Exhibit: IS-LM to Aggregate Demand

Reference: Ref 11-4

(Exhibit: IS-LM to Aggregate Demand) Based on the graph, if LM shifts to LM because the money supply
3

decreases from M to M , then, holding other factors constant:


3

Answer

the aggregate demand curve will shift to the right.


the aggregate demand curve will shift to the left.
this represents a movement up the aggregate demand curve.
this represents a movement down the aggregate demand curve.
Add Question Here

Multiple Choice

0 points

Question
Exhibit: IS-LM to Aggregate Demand

16 of 40

6/1/2012 8:51 PM

Pool Canvas

http://cp03.coursecompass.com/webapps/assessment/do/authoring/view...

Reference: Ref 11-4

(Exhibit: IS-LM to Aggregate Demand) Based on the graph, which is the correct ordering of the price levels
and money supplies?
Answer

P1 > P2 and M1 > M2


P1 > P2 and M1 < M2
P1 < P2 and M1 > M2
P1 < P2 and M1 < M2
Add Question Here

Multiple Choice

0 points

Question
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
______.
Answer

resulting from a change in monetary policy; resulting from a change in fiscal policy
resulting from a change in fiscal policy; resulting from a change in monetary policy
at a given price level; resulting from a change in the price level
resulting from a change in the price level; at a given price level
Add Question Here

Multiple Choice

0 points

Question
A shift in the aggregate demand curve, starting from long-run equilibrium, which increases output in the
short run, will ______ in the long run, as compared to a short-run equilibrium.
Answer

increase both output and the price level


decrease output but increase prices
increase output but decrease the price level
decrease both output and the price level
Add Question Here

Multiple Choice

0 points

Question
If the short-run IS-LM equilibrium occurs at a level of income below the natural level of output, then in the

17 of 40

6/1/2012 8:51 PM

Pool Canvas

http://cp03.coursecompass.com/webapps/assessment/do/authoring/view...

long run the price level will ______, shifting the ______ curve to the right and returning output to the natural
level.
Answer

increase; IS
decrease; IS
increase; LM
decrease; LM
Add Question Here

Multiple Choice

0 points

Question
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.
Answer

price level; increase


interest rate; decrease
money supply; increase
consumption function; decrease
Add Question Here

Multiple Choice

0 points

Question
Exhibit: Short Run to Long Run

Reference: Ref 11-5

(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.
Answer

B; higher
B; lower
C; higher
C; lower
Add Question Here

Multiple Choice

0 points

Question
Exhibit: Short Run to Long Run

18 of 40

6/1/2012 8:51 PM

Pool Canvas

http://cp03.coursecompass.com/webapps/assessment/do/authoring/view...

Reference: Ref 11-5

(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.
Answer

B; higher
B; lower
C; higher
C; lower
Add Question Here

Multiple Choice

0 points

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

output is fixed; prices are fixed


prices are fixed; output is fixed
the interest rate is fixed; the money supply is fixed
prices are flexible; output varies
Add Question Here

Multiple Choice

0 points

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

classical; both the short and long runs


Keynesian; both the short and long runs
classical; the short run whereas the Keynesian assumptions are most appropriate in the long
run
Keynesian; the short run whereas the classical assumptions are most appropriate in the long
run
Add Question Here

Multiple Choice

0 points

Question
The spending hypothesis suggests that the Great Depression was caused by a:

19 of 40

6/1/2012 8:51 PM

Pool Canvas

http://cp03.coursecompass.com/webapps/assessment/do/authoring/view...

Answer

leftward shift in the IS curve.


rightward shift in the IS curve.
leftward shift in the LM curve.
rightward shift in the LM curve.
Add Question Here

Multiple Choice

0 points

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

the decline in investment spending on housing because of a decline in immigration in the


1930s.
the decline in consumption spending caused by the stock market crash of 1929.
fiscal policy to reduce the budget deficit by raising taxes in 1932.
the 25 percent reduction in the money supply between 1929 and 1933.
Add Question Here

Multiple Choice

0 points

Question
The money hypothesis suggests that the Great Depression was caused by a:
Answer

leftward shift in the IS curve.


rightward shift in the IS curve.
leftward shift in the LM curve.
rightward shift in the LM curve.
Add Question Here

Multiple Choice

0 points

Question
The Great Depression in the United States:
Answer

was likely caused by a fall in the money supply because it fell by 25 percent from 1929 to 1933.
cannot be attributed to a fall in the money supply because the money supply did not fall.
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.
probably was caused by a leftward shift in the LM curve because interest rates remained high
between 1929 and 1933.
Add Question Here

Multiple Choice

0 points

Question
The Pigou effect:
Answer

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

Multiple Choice

20 of 40

0 points

6/1/2012 8:51 PM

Pool Canvas

http://cp03.coursecompass.com/webapps/assessment/do/authoring/view...

Question
The Pigou effect suggests that falling prices will increase income because real balances influence ______
and will shift the ______ curve.
Answer

money demand; LM
the money supply; LM
consumer spending; IS
government spending; IS
Add Question Here

Multiple Choice

0 points

Question
If real money balances enter the IS-LM model both through the theory of liquidity preference and the Pigou
effect, than a fall in the price level will shift:
Answer

only the LM curve.


only the IS curve.
both the LM and the IS curves.
neither the LM nor the IS curves.
Add Question Here

Multiple Choice

0 points

Question
If real money balances enter the IS-LM model both through the theory of liquidity preference and the Pigou
effect, than a fall in the price level will result in higher income and:
Answer

higher interest rates.


lower interest rates.
no change in interest rates.
either higher, lower, or unchanging interest rates.
Add Question Here

Multiple Choice

0 points

Question
The debt-deflation theory of the Great Depression suggests that a(n) ______ deflation redistributes wealth
in such a way as to ______ spending on goods and services.
Answer

unexpected; reduce
unexpected; increase
expected; reduce
expected; increase
Add Question Here

Multiple Choice

0 points

Question
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.
Answer

from debtors to creditors; a smaller


from debtors to creditors; a larger
from creditors to debtors; a smaller
from creditors to debtors; a larger
Add Question Here

Multiple Choice

21 of 40

0 points

6/1/2012 8:51 PM

Pool Canvas

http://cp03.coursecompass.com/webapps/assessment/do/authoring/view...

Question
An unexpected deflation can change demand by redistributing wealth from:
Answer

creditors to debtors, thus raising consumption.


creditors to debtors, thus lowering consumption.
debtors to creditors, thus lowering consumption.
debtors to creditors, thus raising consumption.
Add Question Here

Multiple Choice

0 points

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

a shift in the IS curve.


a shift in the LM curve.
the debt-deflation theory.
the Pigou effect.
Add Question Here

Multiple Choice

0 points

Question
Investment depends on the ______ interest rate, and money demand depends on the ______ interest rate.
Answer

real; real
nominal; nominal
real; nominal
nominal; real
Add Question Here

Multiple Choice

0 points

Question
In the IS-LM model, starting with no expected inflation, if expected inflation becomes negative, then the:
Answer

IS curve shifts leftward.


IS curve shifts rightward.
LM curve shifts leftward.
LM curve shifts rightward.
Add Question Here

Multiple Choice

0 points

Question
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.
Answer

lowers; raises
raises; lowers
raises; raises
lowers; lowers
Add Question Here

Multiple Choice

0 points

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

22 of 40

6/1/2012 8:51 PM

Pool Canvas

http://cp03.coursecompass.com/webapps/assessment/do/authoring/view...

Answer

increase in both output and the nominal interest rate.


decrease in both output and the nominal interest rate.
increase in output and a decrease in the nominal interest rate.
decrease in output and an increase in the nominal interest rate.
Add Question Here

Multiple Choice

0 points

Question
Other things equal, an expected deflation can change demand by:
Answer

lowering the demand for money, thus shifting the LM curve.


increasing the demand for money, thus shifting the LM curve.
raising the real interest rate for any given nominal interest rate, thus reducing desired
investment.
lowering the real interest rate for any given nominal interest rate, thus increasing desired
investment.
Add Question Here

Multiple Choice

0 points

Question
During the financial crisis of 200809, many financial institutions stopped making loans even to creditworthy
customers, which could be represented in the IS-LM model as a(n):
Answer

expansionary shift in the IS curve.


contractionary shift in the IS curve.
expansionary shift in the LM curve.
contractionary shift in the LM curve.
Add Question Here

Multiple Choice

0 points

Question
All of the following may have contributed to the financial crisis and economic downturn of 200809 except:
Answer

high inflation.
low interest rates.
stock market volatility.
falling house prices.
Add Question Here

Multiple Choice

0 points

Question
Most economists believe:
Answer

the Great Depression is very likely to be repeated.


it is likely that the money supply might again fall by one-fourth, but that fiscal policy would be
expansionary enough in this case to avoid a Great Depression.
it is unlikely that the money supply might fall again by one-fourth, but it is likely that fiscal policy
might be so contractionary as to cause a Great Depression.
in view of what economists now know about monetary and fiscal policy, and in view of
institutional changes, a repeat of the Great Depression is unlikely.
Add Question Here

Multiple Choice

23 of 40

0 points

6/1/2012 8:51 PM

Pool Canvas

http://cp03.coursecompass.com/webapps/assessment/do/authoring/view...

Question
All of the following were observed during both the Great Depression of the 1930s in the United States and
the Japanese slump of the 1990s except:
Answer

stock prices declined significantly.


banks ran into trouble.
the unemployment rate soared above 20 percent.
interest rates fell to extremely low levels.
Add Question Here

Multiple Choice

0 points

Question
Even though nominal interest rates were already very low, some economists recommended that the Bank of
Japan increase the growth of the money supply in the 1990s in order to:
Answer

decrease real interest rates.


produce negative nominal interest rates.
decrease expected inflation.
decrease money demand.
Add Question Here

Multiple Choice

0 points

Question
A liquidity trap occurs when:
Answer

banks have too much currency and close their doors to new customers.
the central bank mistakenly prints too much money, generating hyperinflation.
interest rates fall so low that monetary policy is no longer effective.
dams and locks are built to prevent flooding.
Add Question Here

Multiple Choice

0 points

Question
If a liquidity trap does exist, then ______ policy will not be effective in increasing income when interest rates
reach very ______ levels.
Answer

monetary; high
monetary; low
fiscal; high
fiscal; low
Add Question Here

Multiple Choice

0 points

Question
If expected inflation equals 3 percent and monetary policymakers push the nominal interest rate to 1
percent, the real interest rate equals ______ percent.
Answer

4
1
0
2
Add Question Here

Multiple Choice

24 of 40

0 points

6/1/2012 8:51 PM

Pool Canvas

http://cp03.coursecompass.com/webapps/assessment/do/authoring/view...

Question
When drawn with the interest rate on the vertical axis and income on the horizontal axis, the IS curve will be
steeper the:
Answer

larger the level of government spending.


smaller the level of government spending.
greater the sensitivity of investment spending to the interest rate.
smaller the sensitivity of investment spending to the interest rate.
Add Question Here

Multiple Choice

0 points

Question
The slope of the IS curve depends on:
Answer

the interest sensitivity of investment and the amount of government spending.


the interest sensitivity of investment and the marginal propensity to consume.
the interest sensitivity of investment and the tax rates.
tax rates and government spending.
Add Question Here

Multiple Choice

0 points

Question
A given increase in taxes shifts the IS curve more to the left the:
Answer

larger the marginal propensity to consume.


smaller the marginal propensity to consume.
larger the government spending.
smaller the government spending.
Add Question Here

Multiple Choice

0 points

Question
The LM curve is steeper the ______ the interest sensitivity of money demand and the ______ the effect of
income on money demand.
Answer

greater; greater
greater; smaller
smaller; smaller
smaller; greater
Add Question Here

Multiple Choice

0 points

Question
If the demand function for money is M/P = 0.5Y 100r, then the slope of the LM curve is:
Answer

0.001.
0.005.
0.01.
0.05.
Add Question Here

Multiple Choice

0 points

Question
If the demand function for money is M/P = 0.5Y 100r and if M/P increases by 100, then the LM curve for
any given interest rate shifts to the:

25 of 40

6/1/2012 8:51 PM

Pool Canvas

http://cp03.coursecompass.com/webapps/assessment/do/authoring/view...

Answer

left by 100.
left by 200.
right by 100.
right by 200.
Add Question Here

Multiple Choice

0 points

Question
Other things equal, a given change in government spending has a larger effect on demand the:
Answer

flatter the LM curve.


steeper the LM curve.
smaller the interest sensitivity of money demand.
larger the income sensitivity of money demand.
Add Question Here

Multiple Choice

0 points

Question
Other things equal, a given change in government spending has a larger effect on demand the:
Answer

flatter the IS curve.


steeper the IS curve.
larger the interest sensitivity of expenditure demand.
smaller the interest sensitivity of money demand.
Add Question Here

Multiple Choice

0 points

Question
Other things equal, a given change in money supply has a larger effect on demand the:
Answer

flatter the IS curve.


steeper the IS curve.
smaller the interest sensitivity of expenditure demand.
smaller the income sensitivity of expenditure demand.
Add Question Here

Multiple Choice

0 points

Question
Other things equal, a given change in money supply has a larger effect on demand the:
Answer

larger the income sensitivity of money demand.


smaller the income sensitivity of money demand.
flatter the LM curve.
steeper the IS curve.
Add Question Here

Multiple Choice

0 points

Question
If money demand does not depend on the interest rate, then the LM curve is ______ and ______ policy has
no effect on output.
Answer

horizontal; fiscal
vertical; fiscal
horizontal; monetary

26 of 40

6/1/2012 8:51 PM

Pool Canvas

27 of 40

http://cp03.coursecompass.com/webapps/assessment/do/authoring/view...

vertical; monetary
Add Question Here
Multiple Choice

0 points

Question
If neither investment nor consumption depends on the interest rate, then the IS curve is ______ and
______ policy has no effect on output.
Answer

vertical; monetary
horizontal; monetary
vertical; fiscal
horizontal; fiscal
Add Question Here

Multiple Choice

0 points

Question
If money demand is infinite below some certain r (e.g., r*) and zero above r*, then the LM curve is ______
and ______ policy has no effect on output.
Answer

vertical; fiscal
horizontal; fiscal
vertical; monetary
horizontal; monetary
Add Question Here

Multiple Choice

0 points

Question
If investment demand is infinite below some certain r (e.g., r**) and zero above r**, then the IS curve is
______ and ______ policy has no effect on output.
Answer

vertical; monetary
horizontal; monetary
vertical; fiscal
horizontal; fiscal
Add Question Here

Multiple Choice

0 points

Question
If the investment demand function is I = c dr and the quantity of real money demanded is eY fr, then
fiscal policy is relatively potent in influencing aggregate demand when d is ______ and f is ______.
Answer

large; small
small; small
small; large
large; large
Add Question Here

Multiple Choice

0 points

Question
If the investment demand function is I = c dr and the quantity of real money demanded is eY fr, then
monetary policy is relatively potent in influencing aggregate demand when d is ______ and f is ______.
Answer

large; small
small; also small
small; large

6/1/2012 8:51 PM

Pool Canvas

http://cp03.coursecompass.com/webapps/assessment/do/authoring/view...

large; also large


Add Question Here
Multiple Choice

0 points

Question
Those economists who believe that fiscal policy is more potent than monetary policy argue that the:
Answer

responsiveness of investment to the interest rate is small.


responsiveness of investment to the interest rate is large.

IS curve is nearly horizontal.


LM curve is nearly vertical.
Add Question Here
Multiple Choice

0 points

Question
Those economists who believe that monetary policy is more potent than fiscal policy argue that the:
Answer

responsiveness of money demand to the interest rate is large.


responsiveness of money demand to the interest rate is small.

IS curve is nearly vertical.


LM curve is nearly horizontal.
Add Question Here
Multiple Choice

0 points

Question
According to the IS-LM model, when the government increases taxes and government purchases by equal
amounts:
Answer

income, the interest rate, consumption, and investment are unchanged.


income and the interest rate rise, whereas consumption and investment fall.
income and the interest rate fall, whereas consumption and interest rise.
income, the interest rate, consumption, and investment all rise.
Add Question Here

Multiple Choice

0 points

Question
If consumption is given by C = 200 + 0.75(Y T) and investment is given by I = 200 25r, then the formula
for the IS curve is:
Answer

Y = 400 0.75T 25r + G.


Y = 1,600 3T 100r + 4G.
Y = 400 + 0.75T 25r G.
Y = 1,600 + 3T 100r 4G.
Add Question Here

Multiple Choice

0 points

Question
If the IS curve is given by Y = 1,700 100r and the LM curve is given by Y = 500 + 100r, then equilibrium
income and interest rate are given by:
Answer

28 of 40

Y = 1,100, r = 6 percent.
Y = 1,200, r = 5 percent.
Y = 1,000, r = 5 percent.
Y = 1,100, r = 5 percent.

6/1/2012 8:51 PM

Pool Canvas

29 of 40

http://cp03.coursecompass.com/webapps/assessment/do/authoring/view...

Add Question Here


Multiple Choice

0 points

Question
d

If the IS curve is given by Y = 1,700 100r, the money demand function is given by (M/P) = 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:
Answer

200 and the interest rate falls by 2 percent.


100 and the interest rate falls by 1 percent.
50 and the interest rate falls by 0.5 percent.
200 and the interest rate remains unchanged.
Add Question Here

Multiple Choice

0 points

Question
If investment does not depend on the interest rate, then the ______ curve is ______.
Answer

IS; vertical
IS; horizontal
LM; vertical
LM; horizontal
Add Question Here

Multiple Choice

0 points

Question
If money demand does not depend on income, then the ______ curve is ______.
Answer

IS; vertical
IS; horizontal
LM; vertical
LM; horizontal
Add Question Here

Multiple Choice

0 points

Question
If money demand is extremely sensitive to the interest rate, then the ______ curve is ______.
Answer

IS; vertical
IS; horizontal
LM; vertical
LM; horizontal
Add Question Here

Multiple Choice

0 points

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

adopt a loose monetary policy but keep fiscal policy unchanged.


adopt a loose monetary policy and a loose fiscal policy.
adopt a loose monetary policy and a tight fiscal policy.
keep monetary policy unchanged but adopt a tight fiscal policy.
Add Question Here

6/1/2012 8:51 PM

Pool Canvas

http://cp03.coursecompass.com/webapps/assessment/do/authoring/view...

Multiple Choice

0 points

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

rise in the real interest rate and a fall in investment.


fall in the real interest rate and a rise in investment.
rise in both the real interest rate and investment.
fall in both the real interest rate and investment.
Add Question Here

Multiple Choice

0 points

Question
An increase in the money supply:
Answer

increases income and lowers the interest rate in both the short and long runs.
increases income in both the short and long runs, but leaves the interest rate unchanged in the
long run.
lowers the interest rate in both the short and long runs, but leaves income unchanged in the
long run.
lowers the interest rate and increases income in the short run, but leaves both unchanged in
the long run.
Add Question Here

Multiple Choice

0 points

Question
An increase in government spending raises income:
Answer

and the interest rate in the short run, but leaves both unchanged in the long run.
in the short run, but leaves it unchanged in the long run, while lowering investment.
in the short run, but leaves it unchanged in the long run, while lowering consumption.
and the interest rate in both the short and long runs.
Add Question Here

Multiple Choice

0 points

Question
An increase in taxes lowers income:
Answer

and the interest rate in the short run, but leaves both unchanged in the long run.
in the short run, but leaves it unchanged in the long run, while increasing consumption and
lowering investment.
in the short run, but leaves it unchanged in the long run, while lowering consumption and
increasing investment.
and the interest rate in both the short and long runs.
Add Question Here

Essay

0 points

Question
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

30 of 40

6/1/2012 8:51 PM

Pool Canvas

http://cp03.coursecompass.com/webapps/assessment/do/authoring/view...

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)?
s

e. Assume that G is back at its original level of 1,000, but M (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
s

divided by the change in M )?


Answer a. Y = 5,000 100r.
b. Y = 3,000 + 100r.
c. In the short-run equilibrium, Y = 4,000, r = 10, Y T = 3,000, C = 2,400, I = 600, private saving
is 600, public saving is 0, and national saving is 600.
d. Y increases by 500. The government spending multiplier is 2.5.
e. Y increases by 250. The multiplier for money supply is 1.25.
Add Question Here
Essay

0 points

Question
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
s

M /P = M /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.

Answer a. Y = 2,700 + 3G 2T 50r.


b. r = 0.01Y 0.02(M/P).
c. For P = 1.0, Y = 2,800 and r = 4; C = 1,566.67 and I = 733.33. For P = 2.0, Y = 2,400 and r = 12;
C = 1,300 and I = 600.
d. Y = 1,800 + 2G (4/3)T + (2/3)M/P.
Add Question Here
Essay

0 points

Question
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.

31 of 40

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.)

6/1/2012 8:51 PM

Pool Canvas

32 of 40

http://cp03.coursecompass.com/webapps/assessment/do/authoring/view...

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?

Answer a. r = 2; T = 1,450; M = 1,900. Private saving = 650; public saving = 250; national saving = 900.
b. r = 8; M = 1,600; I = 600; private saving = 800; public saving = 200; national saving = 600.
c. The policy under part a is tight fiscal, easy money. The policy under part b is loose fiscal, tight
money. The policy under part a most encourages investment.
Add Question Here
Essay

0 points

Question
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.
Answer

Add Question Here


Essay

0 points

Question
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.
Answer

6/1/2012 8:51 PM

Pool Canvas

http://cp03.coursecompass.com/webapps/assessment/do/authoring/view...

Add Question Here


Essay

0 points

Question
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.
Answer

Add Question Here


Essay

0 points

Question
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.
Answer

33 of 40

6/1/2012 8:51 PM

Pool Canvas

http://cp03.coursecompass.com/webapps/assessment/do/authoring/view...

Add Question Here


Essay

0 points

Question
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.
Answer

The interest rate decreases, but the impact on output is ambiguous, depending on whether the IS
or LM curve shifts more.
Add Question Here
Essay

0 points

Question
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.
Answer

34 of 40

6/1/2012 8:51 PM

Pool Canvas

http://cp03.coursecompass.com/webapps/assessment/do/authoring/view...

Both the interest rate and income increase because the falling prices increase money balances,
thus making consumers feel wealthier. The increase in wealth causes consumers to consume
more, thereby shifting the IS curve to the right.
Add Question Here
Essay

0 points

Question
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.
Answer

The increase in expected inflation increases output and the nominal interest rate and lowers the
real interest rate.
Add Question Here
Essay

0 points

Question
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.
Answer

35 of 40

6/1/2012 8:51 PM

Pool Canvas

36 of 40

http://cp03.coursecompass.com/webapps/assessment/do/authoring/view...

Prices increase, reducing real money balances and resulting in lower output and a higher
interest rate.
Add Question Here
Essay

0 points

Question
Two identical countries, Alpha and Beta, can be described by the IS-LM model in the short run. The
governments of both countries cut taxes by the same amount. The Central Bank of Alpha follows a policy of
holding a constant money supply. The Central Bank of Beta follows a policy of holding a constant interest
rate. Compare the impact of the tax cut on income and interest rates in the two countries.
Answer The interest rate will increase in Alpha, but remain constant in Beta. The increase in output will be
larger in Beta because the Central Bank of Beta will increase the money supply to keep the
interest rate constant in the face of the tax cut. Thus, there will be no crowding out of investment in
Beta, but there will be crowding out in Alpha because of the higher interest rate.
Add Question Here
Essay

0 points

Question
Policymakers are contemplating undertaking either an increase in government spending or an increase in
the money supply. Either policy is forecast to have the same impact on income in the short run. Use the
IS-LM model to compare the impact on consumption and investment of the two policy alternatives.
Answer The increase in government spending will increase interest rates, but the increase in the money
supply will lower interest rates. The amount of consumption will be the same under either policy.
There will be less investment if the policy of increasing government spending is chosen because
some investment will be crowded out to accommodate the higher level of government spending.
There will be more investment if the monetary supply expansion is chosen, because interest rates
will be lower.
Add Question Here
Essay

0 points

Question
A decrease in government spending reduces output more in the Keynesian-cross model than in the IS-LM
model. Explain why this is true.
Answer In the Keynesian-cross model, both the price level and interest rate are held constant. A decrease
in government spending reduces output by 1/(1 MPC) times the change in government spending.
In the IS-LM model, the reduction in output caused by the decrease in government spending is
partially offset by an increase in investment (crowding in). In the IS-LM model, the decrease in
government spending reduces income as in the Keynesian-cross model, but the reduction in
income also reduces the demand for money, which in turn reduces the interest rate for a given
money supply. The lower interest rate stimulates the off-setting investment spending.
Add Question Here

6/1/2012 8:51 PM

Pool Canvas

http://cp03.coursecompass.com/webapps/assessment/do/authoring/view...

Essay

0 points

Question
Compare the impact of a tax cut on consumption, investment, output, and interest rates in the classical
model of Chapter 3 versus the IS-LM model.
Answer Output increases in the IS-LM model, but is fixed at the natural level in the classical model
because it is determined by the factors of production and technology. In both models, consumption
increases because the tax cut increases disposable income. The interest rate increases in both
models. In the classical model, the tax cut reduces saving, which increases the interest rate and
reduces the equilibrium quantity of investment. In a closed classical economy, since income is
fixed, the increase in consumption exactly offsets the decrease in investment. In the IS-LM model,
the increase in income increases money demand, which results in a higher interest rate to bring
money demand into equilibrium with the constant money supply. The higher interest rate partially
crowds out investment in the IS-LM model (for the usual interest sensitivities of investment and
money demand).
Add Question Here
Essay

0 points

Question
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.
Answer a.

b. The economy is initially at output Y and interest rate r . As a result of the increase in
n

government spending in the short run, output increases to Y and the interest rate increases to r
1

as the IS curve shifts from IS to IS . In the long run, the price level increases, shifting the LM
1

curve from LM to LM . Output returns to Y and the interest rate eventually increases to r in the
1

long run.
Add Question Here
Essay

0 points

Question
An increase in money supply shifts the LM curve to the right, but an increase in money demand shifts the

37 of 40

6/1/2012 8:51 PM

Pool Canvas

http://cp03.coursecompass.com/webapps/assessment/do/authoring/view...

LM curve to the left. Explain why there is a difference.


Answer When the money supply increases (for a fixed money demand and price level), the demand for
money is less than the money at the existing interest rate, so households use the extra money to
buy bonds, which drives up the price of bonds and reduces the interest rate. The same level of
income is associated with a lower interest rate, which shifts the LM curve downward to the right.
When money demand increases (for a fixed money supply and price level), money demand
exceeds the unchanged money supply, so people start to sell bonds, which drives down the price
of bonds and increases the interest rate. The same level of income is now associated with a higher
interest rate, which shifts the LM curve upward to the left.
Add Question Here
Essay

0 points

Question
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.

Answer

a.

The economy starts in equilibrium at A.


1. With no policy change the price level will eventually fall,
shifting LM1 to LM2. The new long-run equilibrium will be at B.
2. If fiscal policy is used to restore the natural rate, IS1 will shift
to IS2 and the new equilibrium will be at C.

b.

If no policy is used to resotre full employment, the interest rate and the price
level fall. Since the long-run interest rate will be lower, investment will be larger.
If fiscal policy is used, the IS curve will shift to the right. The price level will not
change, but the long-run interest rate will increase. This will reduce the amount
of private investment at the new equilibrium, C.
Add Question Here

Essay

38 of 40

0 points

6/1/2012 8:51 PM

Pool Canvas

39 of 40

http://cp03.coursecompass.com/webapps/assessment/do/authoring/view...

Question
If inflation is bad, why isn't deflation good? Use the IS-LM model to explain how deflation could result in a
contraction in output.
Answer An unexpected deflation will reduce output by transferring wealth from debtors to creditors. If
creditors have a lower propensity to spend than debtors, then the reduction in spending by debtors
will be more than the increase in spending by creditors. This reduction in consumption will shift the
IS curve to the left, resulting in a lower equilibrium level of output.
If there is an expected deflation, this increases the real interest rate at every level of nominal
interest rate and reduces investment spending. The decrease in investment spending shifts the IS
curve to the left and results in a lower equilibrium level of income.
Add Question Here
Essay

0 points

Question
The LM curve can shift to the right if there is an increase in the supply of money or a fall in the price level. In
which case is this movement along the aggregate demand curve and in which case this is a shift of the
aggregate demand curve? Explain.
Answer The aggregate demand curve shows the relationship between income and the price level, holding
other factors constant, including the money supply. An increase in the money supply which shifts
the LM curve to the right also shifts the aggregate demand curve to the right because the money
supply is not constant as it is along any given aggregate demand curve. A reduction in the price
level that shifts the LM curve to the right is a movement down the demand curve, because the
money supply is held constant along the aggregate demand curve and the aggregate demand
curve shows how income changes as the price level changes.
Add Question Here
Essay

0 points

Question
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.
Answer

Starting from A with interest rate r and income Y , the reduction in interest rates by the Fed
1

moves the LM curve to the right. The fall in consumption and investment spending moves the IS
curve to the left. At the new equilibrium the interest rate will be lower, but the impact on output will
depend on the relative magnitudes of the shifts. If the IS curve shifts relatively more than the LM
curve, output will be lower. If the LM curve shifts relatively more than the IS curve, output will
increase.
Add Question Here

6/1/2012 8:51 PM

Pool Canvas

40 of 40

http://cp03.coursecompass.com/webapps/assessment/do/authoring/view...

6/1/2012 8:51 PM

You might also like