Economics Ps 8

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  • 1/20 Questions

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

    • Buy; IS
    • Buy; LM
    • Sell; IS
    • Sell; LM
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Macroeconomics Quizzes & Trivia
About This Quiz

Economics PS 8 is a focused quiz assessing understanding of the IS-LM model in macroeconomics. It examines the effects of monetary and fiscal policy changes on interest rates, output, and investment, crucial for students of advanced economics.

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  • 2. 

    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.

    • Less than

    • Greater than

    • Equal to

    • Sometimes less and sometimes greater than

    Correct Answer
    A. Less than
    Explanation
    In the IS-LM analysis, a tax cut typically leads to a smaller increase in income compared to an equal rise in government spending. This is because when taxes are cut, individuals and businesses have more disposable income, which they may choose to save rather than spend. On the other hand, an increase in government spending directly injects money into the economy, leading to a larger boost in income. Therefore, the increase in income resulting from a tax cut is usually less than the increase in income resulting from an equal rise in government spending.

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  • 3. 

    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 ______.

    • Rises; falls

    • Rises; rises

    • Falls; rises

    • Falls; falls

    Correct Answer
    A. Rises; falls
    Explanation
    In the IS-LM model, when the money supply (M) remains constant but the price level (P) rises, it causes an increase in the demand for money. As a result, the interest rate (r) rises to equilibrate the money market. With a higher interest rate, the cost of borrowing increases, leading to a decrease in investment and overall output (Y). Therefore, in the short-run equilibrium, the interest rate rises while output falls.

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  • 4. 

    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.

    • Lower; raises; reduces

    • Higher; lowers; increases

    • Lower; lowers; increases

    • Higher; raises; reduces

    Correct Answer
    A. Lower; raises; reduces
    Explanation
    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 lower real money supply M/P, which raises the interest rate and reduces spending.

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  • 5. 

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

    • Slopes up to the right.

    • Slopes down to the right.

    • Is horizontal.

    • Is vertical.

    Correct Answer
    A. Is vertical.
    Explanation
    If the demand for real money balances does not depend on the interest rate, it means that individuals and firms are willing to hold the same amount of money regardless of changes in the interest rate. In this case, the LM curve will be vertical because the level of real money balances is fixed and unaffected by changes in the interest rate. This implies that the central bank's monetary policy cannot influence the interest rate to affect the demand for money, resulting in a vertical LM curve.

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  • 6. 

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

    • Increase in the money supply.

    • Increase in government purchases.

    • Decrease in taxes.

    • Increase in money demand.

    Correct Answer
    A. Increase in the money supply.
    Explanation
    In the IS-LM model, a decrease in the interest rate occurs when there is an increase in the money supply. This is because an increase in the money supply leads to a higher supply of loanable funds in the economy, which lowers the interest rate. As a result, individuals and businesses are incentivized to borrow more, leading to increased investment and consumption. Conversely, the other options mentioned - increase in government purchases, decrease in taxes, and increase in money demand - do not directly impact the interest rate in the IS-LM model.

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  • 7. 

    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 ______.

    • Rises; falls

    • Rises; rises

    • Falls; rises

    • Falls; falls

    Correct Answer
    A. Falls; rises
    Explanation
    In the IS-LM model, an increase in the money supply (M) with constant prices (P) will lead to a decrease in the interest rate (r). This is because the increase in money supply lowers the demand for money, causing individuals to invest more and borrow more at lower interest rates. As a result, the interest rate falls. Additionally, the increase in money supply stimulates aggregate demand, leading to an increase in output (Y). Therefore, in short-run equilibrium, the interest rate falls and output rises.

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  • 8. 

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

    • Leftward shift in the IS curve.

    • Rightward shift in the IS curve.

    • Leftward shift in the LM curve.

    • Rightward shift in the LM curve.

    Correct Answer
    A. Leftward shift in the IS curve.
    Explanation
    The spending hypothesis suggests that the Great Depression was caused by a leftward shift in the IS curve. The IS curve represents the relationship between real output and the interest rate in the goods market. A leftward shift in the IS curve indicates a decrease in aggregate demand, which can lead to a decline in real output and an increase in unemployment. This hypothesis suggests that a decrease in spending by consumers and businesses contributed to the economic downturn during the Great Depression.

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  • 9. 

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

    • The budget deficit.

    • Investment.

    • Government expenditures.

    • Taxation.

    Correct Answer
    A. Investment.
    Explanation
    The monetary transmission mechanism refers to the process by which changes in the money supply affect various economic variables. In this case, the correct answer is investment. When the money supply increases, it lowers interest rates, making borrowing cheaper. This encourages businesses to invest in new projects and expand their operations, leading to increased investment. Conversely, a decrease in the money supply would raise interest rates, making borrowing more expensive and potentially discouraging investment. Therefore, changes in the money supply have a direct impact on investment levels in the economy.

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  • 10. 

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

    • Leftward shift in the IS curve.

    • Rightward shift in the IS curve.

    • Leftward shift in the LM curve.

    • Rightward shift in the LM curve.

    Correct Answer
    A. Leftward shift in the LM curve.
    Explanation
    The money hypothesis suggests that the Great Depression was caused by a leftward shift in the LM curve. This means that there was a decrease in the money supply or an increase in the demand for money. This shift led to a decrease in investment and consumption, which in turn caused a decrease in aggregate demand and ultimately led to the economic downturn of the Great Depression.

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  • 11. 

    Use the following to answer questions 16-18: (Exhibit: IS-LM to Aggregate Demand) Based on the graph, which is the correct ordering of the price levels and money supplies?

    • P1 > P2 and M1 > M2

    • P1 > P2 and M1 < M2

    • P1 < P2 and M1 > M2

    • P1 < P2 and M1 < M2

    Correct Answer
    A. P1 > P2 and M1 < M2
    Explanation
    According to the graph, the price level P1 is greater than P2, indicating that there has been an increase in prices over time. On the other hand, the money supply M1 is less than M2, suggesting that there has been an increase in the money supply. Therefore, the correct ordering is P1 > P2 and M1 < M2.

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  • 12. 

    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.

    • Buy; rises; increase

    • Sell; falls; decrease

    • Sell; rises; decrease

    • Buy; rises; decrease

    Correct Answer
    A. Sell; rises; decrease
    Explanation
    When the Federal Reserve decreases the money supply, people sell bonds because there is less money available to invest. As a result, the increased supply of bonds leads to a decrease in their price, which causes the interest rate to rise. This rise in interest rates discourages investment and borrowing, leading to a decrease in both investment and income.

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  • 13. 

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

    • 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.

    Correct Answer
    A. IS curve downward and to the left.
    Explanation
    An increase in consumer saving means that people are spending less of their income, which leads to a decrease in consumption expenditure. This decrease in consumption expenditure will result in a decrease in aggregate demand, causing a leftward shift of the IS curve. Additionally, since saving is a leakage from the income-expenditure flow, an increase in saving will reduce the level of income, leading to a downward shift of the IS curve. Therefore, the correct answer is that an increase in consumer saving will shift the IS curve downward and to the left.

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  • 14. 

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

    • Both consumption and investment remain unchanged.

    • Consumption rises but investment falls.

    • Investment rises but consumption falls.

    • Both consumption and investment fall.

    Correct Answer
    A. Investment rises but consumption falls.
    Explanation
    When taxes are raised, it reduces the disposable income of individuals and businesses, leading to a decrease in consumption. However, the Fed can counteract this by increasing the money supply, which stimulates investment. As a result, investment rises but consumption falls.

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  • 15. 

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

    • Buy; IS

    • Buy; LM

    • Sell; IS

    • Sell; LM

    Correct Answer
    A. Sell; LM
    Explanation
    When bond traders for the Federal Reserve sell bonds, it reduces the money supply in the economy. This leads to a decrease in liquidity, which causes interest rates to increase. The LM curve represents the relationship between interest rates and the level of income in the economy. When bond traders sell bonds, it shifts the LM curve to the left, indicating higher interest rates for a given level of income.

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  • 16. 

    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.

    • 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

    Correct Answer
    A. Decrease output but increase prices
    Explanation
    A shift in the aggregate demand curve, starting from long-run equilibrium, which increases output in the short run, will lead to a situation where the economy is operating above its potential output. In the long run, however, prices will adjust to reflect this higher level of output, causing a decrease in output back to its potential level. At the same time, prices will continue to increase due to the higher demand, resulting in an increase in prices. Therefore, the correct answer is "decrease output but increase prices".

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  • 17. 

    Use the following to answer questions 16-18: (Exhibit: IS-LM to Aggregate Demand) Based on the graph, if LM3 shifts to LM2 because the money supply decreases from M3 to M2 then, holding other factors constant:

    • 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.

    Correct Answer
    A. The aggregate demand curve will shift to the left.
    Explanation
    When the LM curve shifts to the left due to a decrease in money supply, it leads to an increase in interest rates. This increase in interest rates will decrease investment and consumption spending, which will result in a decrease in aggregate demand. Thus, the correct answer is that the aggregate demand curve will shift to the left.

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  • 18. 

    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.

    • Increase; lower

    • Increase; raise

    • Lower; lower.

    • Lower; raise

    Correct Answer
    A. Lower; raise
    Explanation
    An increase in the demand for money, at any given income level and level of interest rates, will lead to a decrease in output and an increase in interest rates within the IS-LM framework. This is because an increase in the demand for money implies that individuals and businesses want to hold more money for transactions and precautionary purposes, reducing their willingness to spend and invest. As a result, aggregate demand decreases, leading to a decrease in output. At the same time, the increased demand for money puts upward pressure on interest rates, as individuals are willing to pay higher rates to borrow money. Therefore, the correct answer is "lower; raise."

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  • 19. 

    Use the following to answer questions 16-18: (Exhibit: IS-LM to Aggregate Demand) Based on the graph, if LM1 shifts to LM2 because the price level decreases from P1 to P2 then, holding other factors constant:

    • 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.

    Correct Answer
    A. This represents a movement down the aggregate demand curve.
    Explanation
    When the LM curve shifts from LM1 to LM2 due to a decrease in the price level from P1 to P2, it indicates a decrease in the money supply. This leads to an increase in interest rates, which in turn decreases investment and consumption. As a result, the aggregate demand curve shifts downward, representing a movement down the aggregate demand curve.

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  • 20. 

    If the short-run IS-LM equilibrium occurs at a level of income below the natural level of output, then in the long run the price level will ______, shifting the ______ curve to the right and returning output to the natural level.

    • Increase; IS

    • Decrease; IS

    • Increase; LM

    • Decrease; LM

    Correct Answer
    A. Decrease; LM
    Explanation
    In the short run, if the IS-LM equilibrium occurs at a level of income below the natural level of output, it implies that there is a deficiency in aggregate demand. As a result, there will be downward pressure on prices in the economy. In the long run, this decrease in the price level will shift the LM (liquidity preference-money supply) curve to the left. This shift occurs because the decrease in prices reduces the demand for money, leading to a decrease in the interest rate. The lower interest rate stimulates investment and increases aggregate demand, eventually returning output to the natural level.

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  • Current Version
  • Mar 21, 2023
    Quiz Edited by
    ProProfs Editorial Team
  • May 13, 2012
    Quiz Created by
    Blackcell_2020

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