Deck 9: The IS-LMAD-AS Model: A General Framework for Macroeconomic Analysis

Question 1

A tax cut on capital will

A) shift the IS curve down and to the left.
B) shift the LM curve up and to the right.
C) shift the IS curve up and to the right.
D) shift the LM curve down and to the left.

Answer 1

C

Question 2

The FE line shows the level of output at which the ________ market is in equilibrium.

A) goods
B) asset
C) labour
D) money

Answer 2

C

Question 3

A temporary increase in government purchases causes the real interest rate to ________ and output to ________.

A) rise; rise
B) rise; fall
C) fall; rise
D) rise; remain unchanged

Answer 3

D

Question 4

Which of the following would shift the FE line to the right?

A) an adverse supply shock
B) a decrease in labour supply
C) an increase in the capital stock
D) an increase in the future marginal productivity of capital

Question 5

A decline in wealth that doesn't affect labour supply would shift the IS curve ________ and the FE line ________.

A) down; is unchanged
B) down; left
C) up; is unchanged
D) up; left

Question 6

A rise in expected future output that doesn't affect labour supply would shift the IS curve ________ and the FE line ________.

A) down; is unchanged
B) down; right
C) up; is unchanged
D) up; right

Question 7

A temporary supply shock, such as a bumper crop, would

A) shift the FE line to the right and leave the IS curve unchanged.
B) shift the FE line to the left and shift the IS curve up.
C) shift the FE line to the left and leave the IS curve unchanged.
D) have no effect on the FE line.

Question 8

Which of the following would shift the LM curve up?

A) an increase in consumer spending
B) an increases in taxes
C) a decrease in supply of money
D) a decrease in taxes

Question 9

The IS curve would unambiguously shift up if there were

A) an increase in both government purchases and corporate taxes.
B) an increase in both government purchases and the expected future marginal product of capital.
C) an increase in the expected future marginal product of capital and a decrease in expected future output.
D) a decrease in both corporate taxes and the expected future marginal product of capital.

Question 10

Which of the following would shift the FE line to the left?

A) a beneficial supply shock
B) a decrease in labour supply
C) an increase in the capital stock
D) a decrease in the future marginal productivity of capital

Question 11

The IS curve shows the combinations of output and the real interest rate for which

A) the goods market is in equilibrium.
B) the labour market is in equilibrium.
C) the financial asset market is in equilibrium.
D) an increase in output will cause the market-clearing interest rate to be bid up.

Question 12

Classical economists argue that an increase in government expenditures will

A) shift FE line to right increasing full-employment output.
B) shift FE line to left decreasing full-employment output.
C) shift FE line to right increasing interest rate.
D) shift FE line to right decreasing labour supply.

Question 13

A temporary supply shock, such as an increase in oil prices, would

A) shift the IS curve down and leave the FE line unchanged.
B) shift the IS curve down and shift the FE line to the left.
C) shift the IS curve up but leave the FE line unchanged.
D) have no effect on the IS curve.

Question 14

The FE line is vertical because the level of output at full employment doesn't depend on the

A) real wage rate.
B) level of employment.
C) marginal product of labour.
D) real interest rate.

Question 15

A temporary decline in government purchases would shift the IS curve ________ and the LM curve ________.

A) down; is unchanged
B) down; left
C) up; is unchanged
D) up; left

Question 16

Any change that reduces desired saving relative to desired investment (for a given level of output) causes the real interest rate to ________ and shifts the IS curve ________.

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

Question 17

A decrease in the effective tax rate on capital would shift the IS curve ________ and the LM curve ________.

A) down; is unchanged
B) down; left
C) up; is unchanged
D) up; left

Question 18

Which of the following will shift IS curve down and to the left?

A) an increase in expected future output
B) a decrease in expected future marginal product of capital
C) a fall in taxes
D) an increase in wealth

Question 19

A rise in the price of a bond causes the yield of the bond to

A) rise.
B) fall.
C) remain unchanged.
D) rise if it's a short-term bond and fall if it's a long-term bond.

Question 20

Because of a widespread fraud, people have decided not to use their debit card for their purchases anymore. This will cause

A) the LM curve to shift down and to the right.
B) the LM curve to shift up and to the left.
C) the IS curve to shift down and to the right.
D) the IS curve to shift up and to the left.

Question 21

Suppose Bank of Canada sells government bonds to the banks and public. This will cause

A) the LM curve to shift up.
B) the IS curve to shift up.
C) the LM curve to shift down.
D) the IS curve to shift down.

Question 22

A financial innovation, such as money market mutual funds, which increases the liquidity of alternatives to money, would

A) increase money demand, shifting the LM curve up.
B) increase money demand, shifting the LM curve down.
C) decrease money demand, shifting the LM curve up.
D) decrease money demand, shifting the LM curve down.

Question 23

People have increased their expectations of inflation from 3% to 5%, directly causing

A) a relative increase in real money demand, shifting the LM curve up.
B) a relative decrease in real money demand, shifting the LM curve down.
C) a relative increase in real money demand, shifting the LM curve down.
D) a relative decrease in real money demand, shifting the LM curve up.

Question 24

What adjusts to restore general equilibrium after a shock to the economy?

A) the LM curve
B) the IS curve
C) the FE line
D) the labour supply curve

Question 25

Banks decide to raise the interest rate they pay on chequing accounts from 4.75% to 5.25%. This action would

A) increase money demand, shifting the LM curve up.
B) increase money demand, shifting the LM curve down.
C) decrease money demand, shifting the LM curve up.
D) decrease money demand, shifting the LM curve down.

Question 26

A change that increases the real money supply relative to real money demand causes

A) the LM curve to shift down.
B) the LM curve to shift up.
C) the IS curve to shift down.
D) the IS curve to shift up.

Question 27

Looking only at the asset market, an increase in output would cause

A) the LM curve to shift down.
B) the LM curve to shift up.
C) an increase in real interest rates along the LM curve.
D) a decrease in real interest rates along the LM curve.

Question 28

To reach general equilibrium, the price level adjusts to shift the ________ until it intersects with the ________.

A) IS curve; FE line and LM curve
B) FE line; LM and IS curves
C) LM curve; FE line and IS curve
D) ND curve; FE line and NS curve

Question 29

You have just read that Australia has suffered a drought, destroying its wheat crop for this year. The effect of this adverse supply shock on Australia would probably be

A) an increase in prices and an increase in real interest rates.
B) an increase in prices, an increase in nominal interest rates, but a decrease in real interest rates.
C) a decrease in prices and an decrease in real interest rates.
D) a decrease in prices, a decrease in nominal interest rates, but an increase in real interest rates.

Question 30

The IS-LM model predicts that a temporary adverse supply shock

A) reduces output, national saving, and investment, but not the real interest rate.
B) reduces output, national saving, and the real interest rate, but not investment.
C) reduces the real interest rate, investment, and output, but not national saving.
D) reduces output, national saving, investment, and the real interest rate.

Question 31

Looking at the macroeconomic statistics for Friedmanland, you discover that at the beginning of the year, the national money supply was equal to $400 million and by the end of the year it was equal to $420 million. You also found out that the inflation rate in Friedmanland was 7%. In this case, you would expect the LM curve to

A) shift up as the real money supply falls.
B) shift up as the real money supply rises.
C) shift down as the real money supply falls.
D) shift down as the real money supply rises.

Question 32

A change that increases real money demand relative to the real money supply causes

A) the LM curve to shift down.
B) the LM curve to shift up.
C) the IS curve to shift down.
D) the IS curve to shift up.

Question 33

The Bank of Canada has announced that it plans to lower the rate of monetary growth from 10% per year to 2% per year. You would expect this announcement to directly

A) increase money demand, shifting the LM curve up.
B) increase money demand, shifting the LM curve down.
C) decrease money demand, shifting the LM curve up.
D) decrease money demand, shifting the LM curve down.

Question 34

An expansionary fiscal policy will lead to

A) an increase in output and an increase in the interest rate.
B) an increase in output and a decrease in the interest rate.
C) a decrease in output and an increase in the interest rate.
D) a decrease in output and a decrease in the interest rate.

Question 35

When all markets in the economy are simultaneously in equilibrium, we say

A) markets are complete.
B) markets are perfect.
C) there is disequilibrium.
D) there is general equilibrium.

Question 36

The probable effect of introducing automatic teller machines is to

A) increase money demand, shifting the LM curve up.
B) increase money demand, shifting the LM curve down.
C) decrease money demand, shifting the LM curve up.
D) decrease money demand, shifting the LM curve down.

Question 37

People have reduced their expectations of inflation from 5% to 3%, directly causing

A) a relative increase in real money demand, shifting the LM curve up.
B) a relative decrease in real money demand, shifting the LM curve down.
C) a relative increase in real money demand, shifting the LM curve down.
D) a relative decrease in real money demand, shifting the LM curve up.

Question 38

A contractionary monetary policy combined with an expansionary fiscal policy will lead to

A) an increase in output and an ambiguous effect on the interest rate.
B) an increase in output and an increase in the interest rate.
C) an ambiguous effect on output and an increase in the interest rate.
D) an ambiguous effect on output and an ambiguous effect on the interest rate.

Question 39

A fall in the price of a bond causes the yield of the bond to

A) rise.
B) fall.
C) remain unchanged.
D) rise if it's a short-term bond and fall if it's a long-term bond.

Question 40

You have just read that the Bank of Canada has increased the money supply to avoid a recession. For a given price level, you would expect the LM curve to

A) shift up as the real money supply falls.
B) shift up as the real money supply rises.
C) shift down as the real money supply falls.
D) shift down as the real money supply rises.

Question 41

An increase in money supply causes the real interest rate to ________ and output to ________ in the short run, before prices adjust to restore equilibrium.

A) rise; rise
B) rise; fall
C) fall; rise
D) fall; fall

Question 42

A decrease in taxes (when Ricardian equivalence doesn't hold) causes the real interest rate to ________ and output to ________ in the short run, before prices adjust to restore equilibrium.

A) rise; rise
B) rise; fall
C) fall; rise
D) fall; fall

Question 43

Classical economists think general equilibrium is attained relatively quickly because

A) the real interest rate adjusts quickly.
B) the level of output adjusts quickly.
C) the real wage rate adjusts quickly.
D) the price level adjusts quickly.

Question 44

Suppose the intersection of the IS and LM curves is to the right of the FE line. What would most likely eliminate a disequilibrium among the asset, labour, and goods markets?

A) a rise in the price level, shifting the LM curve up
B) a fall in the price level, shifting the LM curve down
C) a rise in the price level, shifting the IS curve up
D) a fall in the price level, shifting the IS curve down

Question 45

Under an assumption of monetary neutrality, a change in the nominal money supply has

A) no effect on the price level.
B) a less than proportionate effect on the price level.
C) a proportionate effect on the price level.
D) a more than proportionate effect on the price level.

Question 46

Keynesian economists believe that in the short run,

A) money neutrality exists and prices adjust rapidly.
B) money neutrality does not exist and prices adjust rapidly.
C) money neutrality exists and prices do not adjust rapidly.
D) money neutrality does not exist and prices do not adjust rapidly.

Question 47

A temporary adverse supply shock directly causes

A) a downward shift of the IS curve.
B) a shift to the left of the FE line.
C) a downward shift of the LM curve.
D) an upward shift of the IS curve.

Question 48

An adverse supply shock that is permanent shifts which curve in addition to the curves shifted by one that is temporary?

A) the LM curve
B) the IS curve
C) the FE line
D) the labour demand curve

Question 49

The aggregate demand curve shows

A) the demand for goods depending on the relative price of goods compared to financial assets.
B) the amount of output that can be obtained given the current production function in the economy.
C) the relation between the aggregate quantity of goods demanded and the price level.
D) the relation between the real interest rate and output when the goods market clears.

Question 50

After a temporary adverse supply shock hits the economy, general equilibrium is restored by

A) a downward shift of the IS curve.
B) a shift to the left of the FE line.
C) an upward shift of the LM curve.
D) a downward shift of the LM curve.

Question 51

Which of the following best describes the classical and the Keynesian views on the monetary neutrality?

A) Classical economists believe that money is neutral, but Keynesians do not.
B) Both classical and Keynesian economists believe in monetary neutrality, but they differ in the speed of price adjustment.
C) Classical economists believe in slow adjustment of prices, but Keynesians argue that price adjustment does not take long.
D) Keynesians believe that money affects employment and output in short run and long run, but classical economists argue that money is neutral only in the long run.

Question 52

Suppose the intersection of the IS and LM curves is to the right of the FE line. An increase in the price level would most likely eliminate a disequilibrium among the asset, labour, and goods markets by

A) shifting the LM curve up.
B) shifting the IS curve up.
C) shifting the IS curve down.
D) shifting the FE curve to the left.

Question 53

An increase in money demand causes the real interest rate to ________ and output to ________ in the short run, before prices adjust to restore equilibrium.

A) rise; rise
B) rise; fall
C) fall; rise
D) fall; fall

Question 54

Classical economists believe that in the short run,

A) money neutrality exists and prices adjust rapidly.
B) money neutrality does not exist and prices adjust rapidly.
C) money neutrality exists and prices do not adjust rapidly.
D) money neutrality does not exist and prices do not adjust rapidly.

Question 55

An adverse supply shock to the economy would

A) decrease investment and raise the real interest rate whether the shock were temporary or permanent.
B) decrease investment, but might not raise the real interest rate if the shock were permanent.
C) decrease investment, but might not raise the real interest rate if the shock were temporary.
D) decrease investment, but definitely not raise the real interest rate.

Question 56

An increase in expected inflation causes the real interest rate to ________ and output to ________ in the short run, before prices adjust to restore equilibrium.

A) rise; rise
B) rise; fall
C) fall; rise
D) fall; fall

Question 57

Suppose the intersection of the IS and LM curves is to the left of the FE line. What would most likely eliminate a disequilibrium among the asset, labour, and goods markets?

A) a rise in the price level, shifting the LM curve up
B) a fall in the price level, shifting the LM curve down
C) a rise in the price level, shifting the IS curve up
D) a fall in the price level, shifting the IS curve down

Question 58

A temporary decrease in government purchases causes the real interest rate to ________ and output to ________ in the short run, before prices adjust to restore equilibrium.

A) rise; rise
B) rise; fall
C) fall; rise
D) fall; fall

Question 59

Keynesian economists think general equilibrium is not attained quickly because

A) the real interest rate adjusts slowly.
B) the level of output adjusts slowly.
C) the real wage rate adjusts slowly.
D) the price level adjusts slowly.

Question 60

Which market adjusts the most quickly in response to shocks to the economy?

A) the asset market
B) the labour market
C) the goods market
D) The asset, labour, and goods markets adjust at about the same speed to eliminate a disequilibrium in the macroeconomy.

Question 61

The aggregate demand curve

A) is vertical.
B) slopes upward.
C) is horizontal.
D) slopes downward.

Question 62

The aggregate demand curve shows the combinations of output and the price level that put the economy on

A) the FE line and the IS curve.
B) the FE line, the IS curve, and the LM curve.
C) the IS curve.
D) the IS curve and the LM curve.

Question 63

Which of the following changes shifts the SRAS curve down?

A) a decrease in the labour force
B) a decrease in firms' costs
C) an increase in government purchases
D) a decrease in the money supply

Question 64

The long-run aggregate supply curve

A) is vertical.
B) slopes upward.
C) is horizontal.
D) slopes downward.

Question 65

Which of the following changes shifts the long-run aggregate supply curve to the right?

A) a demographic change that increases the labour supply
B) a decrease in the demand for labor
C) an increase in consumer confidence
D) a decrease in taxes (assuming Ricardian equivalence doesn't hold)

Question 66

When the money supply declines by 10%, in the short run, output ________ and the price level ________.

A) is unchanged; is unchanged
B) declines; falls
C) is unchanged; falls
D) declines; is unchanged

Question 67

For each of the following changes, which equilibrium curve (IS, LM, or FE) is shifted? Draw the change in the underlying demand or supply curves (for example, money demand and supply for the LM curve) and show how the equilibrium curve changes.
a. Expected inflation increases.
b. The future marginal productivity of capital increases.
c. Labour supply decreases.
d. Future income declines.
e. There's a temporary beneficial supply shock.
f. The nominal interest rate on money rises.

Question 68

Which of the following changes shifts the AD curve to the right?

A) a temporary decrease in government purchases
B) a decline in the nominal money supply
C) an increase in corporate taxes
D) an increase in consumer confidence

Question 69

Oil prices have risen temporarily, due to political uncertainty in the Middle East. An advisor to the Bank of Canada suggests, "Higher oil prices reduce aggregate demand. To offset this we must increase the money supply. Then the price level won't need to adjust to restore equilibrium, and we'll prevent a recession." Analyze this statement using the IS-LM model.

Question 70

When SRAS is horizontal, it implies that

A) the price level is fixed.
B) firms can supply whatever level of output is demanded.
C) the price elasticity of SRAS is infinite.
D) all of the above

Question 71

The vertical LRAS implies that

A) the long run supply is not affected by the price level.
B) the price elasticity of supply is zero.
C) in the long run firms supply the full-employment level of output.
D) all of the above.

Question 72

Which of the following changes shifts the SRAS curve up?

A) a decrease in the labour force
B) a decrease in the money supply
C) an increase in government purchases
D) an increase in firms' costs

Question 73

Which of the following statements is not true?

A) Classical macroeconomists think that prices and wages adjust rapidly in response to the shocks.
B) Keynesian macroeconomists think that it may take several years for the economy to reach general equilibrium.
C) Classical and Keynesian macroeconomists both agree that money is neutral in the long run.
D) Keynesian macroeconomists argue that money is neutral in the short run but not in the long run.

Question 74

The aggregate supply curve shows the relation between

A) the real interest rate and the aggregate amount of output that firms supply.
B) the price level and the aggregate amount of output that firms supply.
C) the supply of goods by firms and the price of goods relative to the price of nonmonetary assets.
D) the inflation rate and the unemployment rate.

Question 75

The aggregate demand-aggregate supply (AD-AS) model is

A) different from the IS-LM model because it does not show the long-run equilibrium.
B) equivalent to the IS-LM model but focuses on the relationship between price and output rather than the interest rate and output.
C) different from the IS-LM model because it does not show the short-run equilibrium.
D) equivalent to the IS-LM model but focuses on the relationship between the interest rate and output rather than price and output.

Question 76

The aggregate demand curve slopes downward because

A) people tend to substitute cheaper goods with more expensive goods.
B) the SRAS curve is horizontal.
C) an increase in the price level reduces the aggregate quantity of goods demanded.
D) the LRAS curve is vertical.

Question 77

Which of the following changes shifts the AD curve to the left?

A) a decline in the nominal money supply
B) a decrease in income taxes
C) a decrease in the risk on nonmonetary assets
D) an increase in the future marginal productivity of capital

Question 78

The short-run aggregate supply curve (in the absence of misperceptions)

A) is vertical.
B) slopes upward.
C) is horizontal.
D) slopes downward.

Question 79

Draw a saving-investment diagram to show how each of the following changes shift the IS curve.
a. Future income declines.
b. The future marginal productivity of capital declines.
c. Government purchases increase temporarily.
d. The effective corporate tax rate declines.

Question 80

When the money supply declines by 10%, in the long run, output ________ and the price level ________.

A) is unchanged: is unchanged
B) declines: falls
C) is unchanged; falls
D) declines; is unchanged