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Exam 11: Measuring the Cost of Living

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Question 21

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

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

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Question 22

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

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

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Question 23

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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:

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:

An increase in government spending raises income:

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:

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

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 .

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.

An increase in taxes lowers income:

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

If the IS curve is given by Y = 1,700 - 100r, the money demand function is given by (M/P) d = Y - 100r, the money supply is 1,000, and the price level is 2, then if the money supply is raised to 1,200, equilibrium income rises by:

a. 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.

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

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:

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.

Assume the following model of the economy, with the price level fixed at 1.0: C = 0.8(Y - T) T = 1,000 I = 800 - 20r G = 1,000 Y = C + I + G Ms/P = Md/P = 0.4Y - 40r Ms = 1,200 a. Write a numerical formula for the IS curve, showing Y as a function of r alone. (Hint: Substitute out C, I, G, and T.) b. Write a numerical formula for the LM curve, showing Y as a function of r alone. (Hint: Substitute out M/P.) c. What are the short-run equilibrium values of Y, r, Y - T, C, I, private saving, public saving, and national saving? Check by ensuring that C + I + G = Y and national saving equals I. d. Assume that G increases by 200. By how much will Y increase in short-run equilibrium? What is the government-purchases multiplier (the change in Y divided by the change in G)? e. Assume that G is back at its original level of 1,000, but Ms (the money supply) increases by 200. By how much will Y increase in short-run equilibrium? What is the multiplier for money supply (the change in Y divided by the change in Ms)?

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

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.

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: