Deck 10: Explaining Aggregate Demand: the Is-Mp Model

Question 1

Figure 10.1

Refer to Figure 10.1.If the level of real GDP is initially Y₂,firms will ________ production until equilibrium is reached at ________.

A) increase; Y₂
B) decrease; Y₂
C) increase; Y₁
D) decrease; Y₁

Answer 1

D

Question 2

Figure 10.2

Refer to Figure 10.2.Assume the economy is initially at equilibrium at potential GDP of $250 billion.If the MPC = 0.50 and the difference between AE₁ and AE₂ represents a $75 billion decrease in planned investment spending,real GDP at Y₂ will be equal to

A) $100 billion.
B) $125 billion.
C) $175 billion.
D) $212.5 billion.

Answer 2

A

Question 3

Other things equal,if planned investment spending is greater than actual investment spending,then aggregate expenditure will be ________ real GDP and inventories will ________.

A) greater than; rise
B) greater than; fall
C) less than; rise
D) less than; fall

Answer 3

B

Question 4

If the MPC = 0.80,the tax multiplier is

A) -2.
B) -4.
C) -5.
D) -8.

Question 5

Equilibrium in the goods market occurs where

A) real GDP equals nominal GDP.
B) aggregate expenditure equals autonomous consumption.
C) autonomous consumption equals induced consumption.
D) aggregate expenditure equals real GDP.

Question 6

Table 10.1

(all values are in billions of dollars)
Refer to Table 10.1.The value of the government purchases multiplier in this economy is

A) 0.2.
B) 0.8.
C) 5.
D) 4.

Question 7

Which of the following best represents the consumption function?

A) consumption = autonomous consumption + (the marginal propensity to consume × disposable income)
B) consumption = disposable income - (autonomous consumption / the marginal propensity to consume)
C) consumption = disposable income × (1 / 1 - the marginal propensity to consume)
D) consumption = autonomous consumption + (the marginal propensity to consume × transfer payments) / disposable income

Question 8

Figure 10.2

Refer to Figure 10.2.Assume the economy is initially at equilibrium at potential GDP of $500 billion.If the MPC = 0.80 ,and real GDP falls to Y₂ = $400 billion,the vertical distance between AE₁ and AE₂ must be

A) $8 billion.
B) $20 billion.
C) $80 billion.
D) $100 billion.

Question 9

If the MPC = 0.75,a decrease in government spending from $875 billion to $840 billion will decrease real GDP by

A) $26.25 billion.
B) $35 billion.
C) $46.67 billion.
D) $140 billion.

Question 10

Figure 10.2

Refer to Figure 10.2.If in this economy the MPC = 0.6,Y₂ = $50 billion,and AE₂ is $5 billion below AE₁,potential GDP is

A) $53 billion.
B) $55 billion.
C) $58.3 billion.
D) $62.5 billion.

Question 11

Figure 10.1

Refer to Figure 10.1.If the level of real GDP is initially Y₃,spending is ________ production and there is an unexpected ________ in inventories.

A) greater than; increase
B) greater than; decrease
C) less than; increase
D) less than; decrease

Question 12

Figure 10.1

Refer to Figure 10.1.If the level of real GDP is initially Y₃,firms will ________ production until equilibrium is reached at ________.

A) increase; Y₃
B) decrease; Y₃
C) increase; Y₁
D) decrease; Y₁

Question 13

Table 10.1

(all values are in billions of dollars)
Refer to Table 10.1.Equilibrium real GDP for this economy is equal to

A) $5.75 billion.
B) $12 billion.
C) $17.6 billion.
D) $46 billion.

Question 14

If the MPC = 0.75,a decrease in personal taxes from $100 billion to $80 billion will increase real GDP by

A) $20 billion.
B) $40 billion.
C) $60 billion.
D) $80 billion.

Question 15

Table 10.1

(all values are in billions of dollars)
Refer to Table 10.1.The value of the tax multiplier in this economy is

A) 0.
B) -2.
C) -3.
D) -5.

Question 16

Figure 10.1

Refer to Figure 10.1.If the level of real GDP is initially Y₂,spending is ________ production and there is an unexpected ________ in inventories.

A) greater than; increase
B) greater than; decrease
C) less than; increase
D) less than; decrease

Question 17

If the MPC = 0.80,the government purchases multiplier is

A) 2.
B) 4.
C) 5.
D) 8.

Question 18

Table 10.1

(all values are in billions of dollars)
Refer to Table 10.1.Suppose that all of the information given in the table remains the same except that taxes equal $0.5 billion.Equilibrium real GDP for this economy is equal to

A) $6.25 billion.
B) $17.7 billion.
C) $16.1 billion.
D) $47.3 billion.

Question 19

If the MPC = 0.8,an increase in investment spending from $35 billion to $38 billion will increase real GDP by

A) $3 billion.
B) $3.75 billion.
C) $15 billion.
D) $24 billion.

Question 20

Other things equal,if planned investment spending is less than actual investment spending,then aggregate expenditure will be ________ real GDP and employment will ________.

A) greater than; increase
B) greater than; decrease
C) less than; increase
D) less than; decrease

Question 21

Explain how an increase in the real interest rate,with no changes to other factors that affect aggregate expenditure,impacts aggregate expenditure and how this interest rate increase is shown on the IS curve.How would this change if there was a negative demand shock with no change in the real interest rate? Show both situations using graphs for aggregate expenditure and the IS curve.

Question 22

Figure 10.3

Panel (a) Panel (b)
Refer to Figure 10.3.A negative demand shock accompanied by an increase in the real interest rate is best represented by ________ in panel (a)and ________ in panel (b).

A) a shift from AE₃ to AE₂; a movement from point C to point B
B) a shift from AE₂ to AE₃; a shift from IS₁ to IS₂
C) a shift from AE₂ to AE₁; a movement from point B to point A
D) a shift from AE₃ to AE₁; a movement from point C to point A

Question 23

Suppose the economy is initially in equilibrium at potential GDP = $100 billion and investment increases by $8 billion.If the MPC in this economy is 0.8,what will happen to real GDP? Draw an aggregate expenditure graph showing this change in investment and real GDP.

Question 24

The IS curve shows the combinations of ________ and ________ where the goods market is in equilibrium.

A) aggregate expenditure; real GDP
B) the real interest rate; real GDP
C) potential GDP; aggregate expenditure
D) the nominal interest rate; the quantity of money

Question 25

Figure 10.3

Panel (a) Panel (b)
Refer to Figure 10.3.A positive demand shock accompanied by a decrease in the real interest rate is best represented by ________ in panel (a)and ________ in panel (b).

A) a shift from AE₂ to AE₃; a movement from point B to point C
B) a shift from AE₃ to AE₂; a shift from IS₂ to IS₁
C) a shift from AE₁ to AE₂; a movement from point A to point B
D) a shift from AE₁ to AE₃; a movement from point A to point C

Question 26

Changes in the real interest rate affect all of the following components of aggregate expenditure,except

A) consumption.
B) investment.
C) government purchases.
D) net exports.

Question 27

Other things equal,when the real interest rate falls,C,I,and NX ________ and the output gap will ________.

A) decrease; decrease
B) decrease; increase
C) increase; increase
D) increase; decrease

Question 28

The Bank of Canada has control over the long-term real interest rate provided that three variables remain unchanged.These three variables include all of the following,except

A) the expected rate of inflation.
B) the default premium.
C) term structure effects.
D) the short-term real interest rate.

Question 29

Figure 10.3

Panel (a) Panel (b)
Refer to Figure 10.3.A positive demand shock with no change in the real interest rate is best represented by ________ in panel (a)and ________ in panel (b).

A) a shift from AE₃ to AE₂; a shift from IS₂ to IS₁
B) a shift from AE₂ to AE₃; a shift from IS₁ to IS₂
C) a shift from AE₁ to AE₂; a movement from point A to point B
D) a shift from AE₁ to AE₃; a movement from point A to point C

Question 30

Figure 10.3

Panel (a) Panel (b)
Refer to Figure 10.3.An increase in the real interest rate,with no other changes that affect aggregate expenditure,is best represented by ________ in panel (a)and ________ in panel (b).

A) a shift from AE₂ to AE₃; a shift from IS₁ to IS₂
B) a shift from AE₃ to AE₂; a shift from IS₂ to IS₁
C) a shift from AE₂ to AE₁; a movement from point B to point A
D) a shift from AE₃ to AE₁; a movement from point C to point A

Question 31

Figure 10.3

Panel (a) Panel (b)
Refer to Figure 10.3.A decrease in the real interest rate,with no other changes that affect aggregate expenditure,is best represented by ________ in panel (a)and ________ in panel (b).

A) a shift from AE₃ to AE₂; a shift from IS₂ to IS₁
B) a shift from AE₂ to AE₃; a shift from IS₁ to IS₂
C) a shift from AE₁ to AE₂; a movement from point A to point B
D) a shift from AE₁ to AE₃; a movement from point A to point C

Question 32

If the long-term real interest rate is 5.1%,the term structure effect is 2.0%,the default-risk premium is 1.7%,and the expected rate of inflation is 3.3%,the short-term nominal interest rate will be

A) -1.9%.
B) 4.7%.
C) 5.5%.
D) 12.1%.

Question 33

Which of the following equations best represents the long-term real interest rate? The long-term real interest rate =

A) the short-term real interest rate + the term structure effect + the default-risk premium + the expected rate of inflation
B) the short-term nominal interest rate + the term structure effect + the default-risk premium - the expected rate of inflation
C) the long-term nominal interest rate + the term structure effect + the default-risk premium - the expected rate of inflation
D) the short-term nominal interest rate - the term structure effect - the default-risk premium + the expected rate of inflation

Question 34

Figure 10.3

Panel (a) Panel (b)
Refer to Figure 10.3.A negative demand shock with no change in the real interest rate is best represented by ________ in panel (a)and ________ in panel (b).

A) a shift from AE₃ to AE₂; a shift from IS₂ to IS₁
B) a shift from AE₂ to AE₃; a shift from IS₁ to IS₂
C) a shift from AE₂ to AE₁; a movement from point B to point A
D) a shift from AE₃ to AE₁; a movement from point C to point A

Question 35

Suppose that the marginal propensity to consume is 0.75.
a. If the government decreases spending by $500 billion,what is the change in output?
b. If the government decreases taxes by $500 billion,what is the change in output?
c. If the government decreases spending by $500 billion and at the same time decreases taxes by $500 billion,what is the change in output?

Question 36

For each of the following changes,identify whether there will be a shift in the IS curve or a movement along the IS curve.In each case identify the direction of the movement or shift.
a. The real interest rate decreases.
b. The government decreases tax rates.
c. Government spending decreases.
d. Investors become optimistic about future profitability.

Question 37

Other things equal,when the real interest rate rises,C,I,and NX ________ and real GDP will ________ relative to potential GDP.

A) decrease; decrease
B) decrease; increase
C) increase; increase
D) increase; decrease

Question 38

If the short-term nominal interest rate is 3.4%,the term structure effect is 1.2%,the default-risk premium is 1.4%,and the expected rate of inflation is 2.7%,the long-term real interest rate will be

A) -1.9%.
B) 0.5%.
C) 3.3%.
D) 8.7%.

Question 39

Table 10.1

(all values are in billions of dollars)
Refer to Table 10.1.Suppose that all of the information given in the table remains the same except that taxes equal $0.5 billion.If potential GDP equals $17 billion,by how much would taxes have to decrease for equilibrium GDP to equal potential GDP?

A) $1.9 billion
B) $0.3 billion
C) $1.5 billion
D) $5 billion

Question 40

Table 10.1

(all values are in billions of dollars)
Refer to Table 10.1.Suppose that all of the information given in the table remains the same except that taxes equal $0.5 billion.If potential GDP equals $17 billion,by how much would government purchases have to change for equilibrium GDP to equal potential GDP?

A) $0.225 billion
B) $1.25 billion
C) $1.5 billion
D) $5 billion

Question 41

Assume the economy is initially in equilibrium where potential GDP is less than real GDP.If the expected inflation rate,the term structure effect,and the default-risk premium are constant,________ in the Bank of Canada's short-term nominal interest rate will shift the MP curve up,which will result in real GDP ________.

A) an increase; falling
B) an increase; rising
C) a decrease; falling
D) a decrease; rising

Question 42

List three factors that will cause the MP curve to shift.Explain what needs to happen to each of these factors to cause the MP curve to shift upward and to shift downward.

Question 43

Holding other factors constant,a decline in incomes of Europeans will result in a ________ curve in Canada,reducing real GDP relative to potential GDP.

A) leftward shift of the IS
B) rightward shift of the IS
C) upward shift of the MP
D) downward shift of the MP

Question 44

If the Bank of Canada keeps the real interest rate constant,the recovery of a weak housing market would cause the ________,and the output gap would ________.

A) MP curve to shift up; become less negative
B) MP curve to shift down; become more negative
C) IS curve to shift to the left; become more negative
D) IS curve to shift to the right; become less negative

Question 45

Figure 10.5

Refer to Figure 10.5.A shift from MP₁ to MP₂ will occur if

A) investors decrease the short-term interest they expect in the future.
B) investors decrease the term premium they require on long-term bonds.
C) the default-risk premium decreases.
D) the expected inflation rate decreases.

Question 46

Figure 10.4

Refer to Figure 10.4.Suppose the economy's equilibrium starts out with an output gap of ₁,and real GDP increases so the C ₂.If the Bank of Canada keeps the money supply constant,money demand will ________ and the nominal interest rate will ________.

A) increase; increase
B) increase; decrease
C) increase; remain constant
D) remain constant; remain constant

Question 47

Assume the economy is initially in equilibrium where potential GDP equals real GDP.If the expected inflation rate,the term structure effect,and the default-risk premium are constant and the Bank of Canada wants to lower the inflation rate,the Bank of Canada could ________ the target short-term nominal interest rate,which will result in real GDP being ________ potential GDP.

A) increase; greater than
B) increase; less than
C) decrease; greater than
D) decrease; less than

Question 48

Figure 10.5

Refer to Figure 10.5.A shift from MP₁ to MP₃ will occur if

A) investors increase the short-term interest they expect in the future.
B) investors increase the term premium they require on long-term bonds.
C) the Bank of Canada decreases its target for the short-term nominal interest rate.
D) the expected inflation rate decreases.

Question 49

Assuming everything else constant,what effect will each of the following have on the long-term real interest rate?
a. The expected inflation rate decreases.
b. The default-risk premium increases.
c. Investors expect future short-term interest rates to fall.

Question 50

Assume the long-term real interest rate is 4% and the expected inflation rate is 5%.If the Bank of Canada decreases the money supply and as a result,the expected inflation rate decreases to 2%,then based on the Fisher effect,the long-term real interest rate will ________ and the long-term nominal interest rate will ________.

A) remain at 4%; rise to 7%
B) remain at 4%; fall to 6%
C) fall to 1%; fall to 6%
D) fall to 6%; remain at -1%

Question 51

Assume the economy is initially in equilibrium where potential GDP equals real GDP.If the economy experiences a ________ demand shock and the Bank of Canada does not change its target short-term nominal interest rate,the IS curve shifts to the left and real GDP will be ________ potential GDP.

A) positive; greater than
B) positive; less than
C) negative; greater than
D) negative; less than

Question 52

Assume the economy is initially in equilibrium where potential GDP is greater than real GDP.If the expected inflation rate,the term structure effect,and the default-risk premium are constant,a decrease in the Bank of Canada's target short-term nominal interest rate will ________ the MP curve and the output gap will become ________.

A) shift up; smaller
B) shift up; larger
C) shift down; smaller
D) shift down; larger

Question 53

Figure 10.4

Refer to Figure 10.4.Suppose the economy's equilibrium starts out with an output gap of ₁,and real GDP increases so the output gap increases to ₂.If the Bank of Canada wants to keep the interest rate at the target,the money demand curve will ________ and the money supply curve will ________.

A) shift from MD₁ to MD₂; shift from MS₁ to MS₂
B) shift from MD₂ to MD₁; shift from MS₂ to MS₁
C) remain at MD₁; remain at MS₁
D) remain at MD₂; remain at MS₂

Question 54

Assume the economy is initially in equilibrium where potential GDP equals real GDP.If the expected inflation rate,the term structure effect,and the default-risk premium are constant and the Bank of Canada wants to ________ the inflation rate,the Bank of Canada could lower the target short-term nominal interest rate,which will result in an output gap which is ________.

A) raise; greater than zero
B) raise; less than zero
C) lower; greater than zero
D) lower; less than zero

Question 55

Figure 10.5

Refer to Figure 10.5.A shift from MP₁ to MP₂ will occur if

A) the Bank of Canada decreases its target for the short-term nominal interest rate.
B) the term structure effect increases.
C) the default-risk premium decreases.
D) the expected inflation rate increases.

Question 56

Assume the long-term nominal interest rate is 7% and the expected inflation rate is 3%.If the Bank of Canada increases the money supply and as a result,the expected inflation rate increases to 5%,then based on the Fisher effect,the long-term real interest rate will

A) remain at 4%.
B) increase to 6%.
C) fall to 3%.
D) increase to 9%.

Question 57

Figure 10.4

Refer to Figure 10.4.Suppose the economy's equilibrium starts out with an output gap of ₁,and real GDP increases so the output gap increases to ₂.If the Bank of Canada acts to keep the short-term nominal interest rate at the target and the term structure effect,the default-risk premium,and the expected inflation rate remain constant,then the long-term nominal interest rate will

A) increase.
B) decrease.
C) remain constant.
D) be indeterminate, since the Bank of Canada has no control over long-term rates.

Question 58

Figure 10.6

Refer to Figure 10.6.Suppose the economy is originally in equilibrium at point A in the above figure.Explain what happens to the money supply and money demand if real GDP increases and changes the output gap if the Bank of Canada wants to keep the nominal interest rate at its target,and show these changes on the money market graph.Use the new money market graph to derive an MP curve.

Question 59

Figure 10.5

Refer to Figure 10.5.A shift from MP₁ to MP₃ will occur if

A) the term structure effect increases.
B) the default-risk premium decreases.
C) investors increase the short-term interest they expect in the future.
D) the Bank of Canada increases its target for the short-term nominal interest rate.

Question 60

If the Bank of Canada keeps the real interest rate constant,an economic shock such as a housing market crash would cause the ________,and the output gap would ________.

A) MP curve to shift up; increase
B) MP curve to shift down; decrease
C) IS curve to shift to the left; decrease
D) IS curve to shift to the right; increase

Question 61

Expansionary monetary policy causes a ________ the MP curve and a ________ the aggregate demand curve.

A) movement to the right along; shift to the right of
B) downward shift of; shift to the right of
C) movement to the left along; movement down along
D) upward shift of; shift to the right of

Question 62

Assume the economy is in a recession and the federal government decides to cut personal income tax rates.All else equal,the cut in tax rates should

A) shift the IS curve to the right and move the output gap closer to zero.
B) shift the IS curve to the left and move the output gap farther away from zero.
C) shift up the MP curve and move the output gap closer to zero.
D) shift up the MP curve and move the output gap farther away from zero.

Question 63

Explain how the AD curve can be derived from the IS-MP model.

Question 64

A negative demand shock causes a ________ the IS curve and a ________ the aggregate demand curve.

A) movement up along; shift to the left of
B) shift to the right of; movement up along
C) movement down along; movement down along
D) shift to the left of; shift to the left of

Question 65

Using the IS-MP model,explain what happens to output and the real interest rate when the IS curve shifts to the right and when it shifts to the left,and when the MP curve shifts up and when it shifts down.

Question 66

A decrease in the price level causes a ________ the IS curve and a ________ the aggregate demand curve.

A) movement up along; movement up along
B) shift to the right of; movement up along
C) movement down along; movement down along
D) shift to the left of; movement down along

Question 67

Figure 10.7

Refer to Figure 10.7.A movement from point C to point A could be caused by

A) a negative demand shock.
B) a decrease in the term premium investors expect in the future.
C) a decrease in the default-risk premium.
D) a decrease in the expected rate of inflation.

Question 68

Figure 10.7

Refer to Figure 10.7.A movement from point A to point B could be caused by

A) a negative demand shock.
B) a decrease in the term premium investors expect in the future.
C) an increase in the default-risk premium.
D) an increase in the expected rate of inflation.

Question 69

Figure 10.7

Refer to Figure 10.7 A movement from point D to point C could be caused by

A) a positive demand shock.
B) an increase in the term premium investors expect in the future.
C) an increase in the term structure effect.
D) an increase in the expected rate of inflation.

Question 70

Contractionary monetary policy causes a ________ the MP curve and a ________ the aggregate demand curve.

A) movement to the right along; shift to the right of
B) downward shift of; shift to the right of
C) movement to the left along; movement up along
D) upward shift of; shift to the left of

Question 71

A positive demand shock causes a ________ the IS curve and a ________ the aggregate demand curve.

A) movement up along; shift to the right of
B) shift to the right of; movement down along
C) movement down along; movement down along
D) shift to the right of; shift to the right of

Question 72

Assume the economy is initially in equilibrium where potential GDP equals real GDP.If the economy experiences a positive demand shock,increasing consumer optimism,and the Bank of Canada does not change its target short-term nominal interest rate,the ________ shifts to the right and the output gap will be ________.

A) IS curve; positive
B) IS curve; negative
C) MP curve; positive
D) MP curve; negative

Question 73

Suppose that the economy is experiencing inflation and is above full employment,and the federal government implements an income tax increase as a corrective action.Use the IS-MP model to analyze the effect the tax increase should have on real GDP and the output gap.Show any shifts in the IS curve and the MP curve,and identify the old and new equilibrium values of the output gap.

Question 74

Figure 10.7

Refer to Figure 10.7.A movement from point A to point D could be caused by

A) a positive demand shock accompanied by an increase in the default-risk premium.
B) a decrease in consumer confidence accompanied by a a decrease in the expected rate of inflation.
C) a negative demand shock accompanied by an increase in the target interest rate.
D) an increase in consumer confidence accompanied by a decrease in the term premium investors expect in the future.

Question 75

The IS-MP model assumes the Bank of Canada targets ________,and the IS-LM model assumes the Bank of Canada targets ________.

A) the expected inflation rate; the unemployment rate
B) the short-term nominal interest rates; the money supply
C) the output gap; the long-term real interest rate
D) short-term real interest rates; the expected inflation rate

Question 76

An increase in the price level causes a ________ the IS curve and a ________ the aggregate demand curve.

A) movement up along; movement down along
B) shift to the right of; movement down along
C) movement up along; movement up along
D) shift to the left of; movement up along

Question 77

The aggregate demand curve is all of the equilibrium combinations of

A) the IS curve and the MP curve.
B) the output gap and the price level.
C) the price level and the real interest rate.
D) the real interest rate and the output gap.

Question 78

Assume the economy is in a recession and the federal government decides to cut personal income tax rates.All else equal,the cut in tax rates should

A) increase consumption expenditures and cause real GDP to increase relative to potential GDP.
B) increase the nominal interest rate and cause potential GDP to increase relative to real GDP.
C) decrease the real interest rate and decrease expectations of inflation.
D) increase the target interest rate and cause real GDP to fall relative to potential GDP.

Question 79

Figure 10.7

Refer to Figure 10.7.A movement from point C to point B could be caused by

A) an increase in consumer confidence accompanied by a decrease in the target interest rate.
B) a decrease in consumer confidence accompanied by an increase in the expected rate of inflation.
C) a negative demand shock accompanied by an increase in the term structure effect.
D) a positive demand shock accompanied by a decrease in the default-risk premium.

Question 80

Figure 10.7

Refer to Figure 10.7.A movement from point B to point D could be caused by

A) an increase in the target interest rate.
B) an increase in consumer confidence.
C) an increase in the term structure effect.
D) a decrease in the expected rate of inflation.