Use the following to answer question 4. Exhibit: Keynesian Cross

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1 1. Two interpretations of the IS LM model are that the model explains: A) the determination of income in the short run when prices are fixed, or what shifts the aggregate demand curve. B) the short-run quantity theory of income, or the short-run Fisher effect. C) the determination of investment and saving, or what shifts the liquidity preference schedule. D) changes in government spending and taxes, or the determination of the supply of real money balances. 2. The IS curve plots the relationship between the interest rate and that arises in the market for. A) national income; goods and services B) the price level; goods and services C) national income; money D) the price level; money 3. When planned expenditure is drawn on a graph as a function of income, the slope of the line is: A) zero. B) between zero and one. C) one. D) greater than one. Use the following to answer question 4. Exhibit: Keynesian Cross 4. (Exhibit: Keynesian Cross) In this graph, if firms are producing at level Y 1, then

2 inventories will, inducing firms to production. A) rise; increase B) rise; decrease C) fall; increase D) fall; decrease 5. According to the Keynesian-cross analysis, when there is a shift upward in the government-purchases schedule by an amount ΔG and the planned expenditure schedule by an equal amount, then equilibrium income rises by: A) one unit. B) ΔG. C) ΔG divided by the quantity one minus the marginal propensity to consume. D) ΔG multiplied by the quantity one plus the marginal propensity to consume. 6. In the Keynesian-cross model, if taxes are reduced by 100, then planned expenditures for any given level of income. A) increase by 100 B) increase by more than 100 C) decrease by 100 D) increase, but by less than In the Keynesian-cross model with a given MPC, the government-expenditure multiplier the tax multiplier. A) is larger than B) equals C) is smaller than D) is the inverse of the 8. Tax cuts stimulate by improving workers' incentive and expand by raising households' disposable income. A) velocity; demand for loanable funds B) demand for loanable funds; velocity C) aggregate demand; aggregate supply D) aggregate supply; aggregate demand 9. When drawn on a graph with income along the horizontal axis and the interest rate along the vertical axis, the IS curve generally: A) is vertical. B) is horizontal. C) slopes upward and to the right. D) slopes downward and to the right.

3 10. An IS curve shows combinations of: A) taxes and government spending. B) nominal money balances and price levels. C) interest rates and income that bring equilibrium in the market for real balances. D) interest rates and income that bring equilibrium in the market for goods and services. 11. The IS curve generally determines: A) income. B) the interest rate. C) both income and the interest rate. D) neither income nor the interest rate. 12. Reducing the money supply nominal interest rates in the short run, and nominal interest rates in the long run. A) produces no change in; raises B) raises; produces no change in C) raises; lowers D) lowers; raises 13. An explanation for the slope of the LM curve is that as: A) the interest rate increases, income becomes higher. B) the interest rate increases, income becomes lower. C) income rises, money demand rises, and a higher interest rate is required. D) income rises, money demand rises, and a lower interest rate is required. 14. At a given interest rate, an increase in the nominal money supply the level of income that is consistent with equilibrium in the market for real balances. A) raises B) lowers C) does not change D) may either raise or lower 15. The LM curve shows combinations of that are consistent with equilibrium in the market for real money balances. A) inflation and unemployment B) the price level and real output C) the interest rate and the level of income D) the interest rate and real money balances

4 16. The intersection of the IS and LM curve determines the values of: A) r, Y, and P, given G, T, and M. B) r, Y, and M, given G, T, and P. C) r and Y, given G, T, M, and P. D) p and Y, given G, T, and M. 17. The IS LM model is generally used: A) only in the short run. B) only in the long run. C) both in the short run and the long run. D) in determining the price level. 18. Suppose Congress decides to reduce the budget deficit by cutting government spending. Use a. the Keynesian-cross model to illustrate graphically the impact of a reduction in government purchases on the equilibrium level of income. Be sure to label: i. the axes; ii. the curves; iii. the initial equilibrium values; iv. the direction the curve shifts; and v. the terminal equilibrium values. b. Explain in words what happens to equilibrium income as a result of the cut in government spending and the time horizon appropriate for this analysis. 19. Graphically illustrate the impact of an open-market purchase by the Federal Reserve on the a. equilibrium interest rate using the theory of liquidity preference and the market for real money balances. Be sure to label: i. the axes; ii. the curves; iii. the initial equilibrium values; iv. the direction the curve shifts; and v. the terminal equilibrium values. b. Explain in words what happens to the equilibrium interest rate as a result of the open-market purchase. 20. As an economy moves into a recession, income falls. Illustrate graphically the impact of a a. decrease in income on the equilibrium interest rate using the theory of liquidity preference and the market for real money balances. Be sure to label: i. the axes; ii. the curves; iii. the initial equilibrium values; iv. the direction the curve shifts; and v. the terminal equilibrium values. b. Explain in words what happens to the equilibrium interest rate as a result of the fall in income. Answer Key - Untitled Exam-1

5 1. A 2. A 3. B 4. C 5. C 6. D 7. A 8. D 9. D 10. D 11. D 12. C 13. C 14. A 15. C 16. C 17. A 18. a. 19. a. b. The equilibrium level of income falls. This analysis is appropriate in the short run when prices and the interest rate are constant.

6 20. a. b. The equilibrium interest rate falls. b. The equilibrium interest rate falls.