Deck 18: Monetary Theory II: The IS-MP Model

Question 1

The marginal propensity to consume can best be described as:

A)consumption/income
B)the impact of a change in income on GDP
C)the change in income divided by the change in consumption
D)the change in consumption divided by the change in income

Answer 1

consumption/income

Question 2

What three parts of the economy are represented in the IS-MP model?

Answer 2

The IS curve, which represents equilibrium in the market for goods and services. The MP curve, which represents Federal Reserve monetary policy. The Phillips curve, which represents the short-run relationship between the output gap and the inflation rate.

Question 3

What effect would economic weakness in Europe due to a sovereign debt crisis have on the U.S. economy?

A)IS shifts to the right
B)IS shifts to the left
C)potential GDP increases
D)potential GDP decreases

Answer 3

IS shifts to the left

Question 4

The series of induced changes in consumption spending that result from an initial change in autonomous expenditure is called the

A)induced effect.
B)autonomous effect.
C)multiplier effect.
D)consumption effect

Question 5

If AE > Y, which of the following will NOT occur?

A)inventories will decline
B)actual investment will be more than planned investment
C)employment will increase
D)GDP will increase

Question 6

Which of the following would NOT cause the IS curve to shift to the left?

A)a decrease in government purchases
B)an increase in consumer confidence
C)a decrease in foreign demand for domestic products
D)a decrease in the expected future profitability of capital

Question 7

Which of the following statements about potential GDP is false?

A)The Fed's goal is to have equilibrium GDP close to potential GDP.
B)When GDP is at potential, cyclical unemployment is zero.
C)It occurs when firms are producing at their maximum level of output.
D)It occurs when firms are producing with a workforce of normal size working normal hours.

Question 8

An increase in the expected profitability of investment will cause

A)IS to shift right.
B)IS to shift left.
C)MP to shift upward.
D)MP to shift downward.

Question 9

An autonomous expenditure is one that does not depend on:

A)government policy
B)the automobile sector
C)interest rates
D)GDP

Question 10

Which of the following does NOT lead to an increase in potential GDP?

A)labor force grows
B)technological change takes place
C)new machinery and equipment are installed
D)aggregate expenditures increase

Question 11

In a move up the IS curve,

A)investment rises.
B)output falls.
C)the real interest rate falls.
D)saving rises.

Question 12

If a $10 billion increase in investment leads to a $20 billion increase in GDP, the multiplier is

A)0)5
B)2
C)10
D)30

Question 13

In a simple model of the economy, if the MPC is 0.8, the multiplier will equal

A)0)2
B)0)8
C)1)25
D)5

Question 14

The IS curve depicts the relationship between

A)aggregate output and the real interest rate.
B)investment demand and the real interest rate.
C)investment demand and the level of current output.
D)national saving and the level of current output.

Question 15

Which of the following would NOT cause a shift in the IS curve?

A)an increase in the domestic real interest rate
B)an increase in consumer confidence
C)a decrease in the expected future profitability of capital
D)a decrease in government purchases

Question 16

An increase in the real interest rate causes

A)the IS curve to shift to the right.
B)the IS curve to shift to the left.
C)a movement up the IS curve.
D)a movement down the IS curve.

Question 17

If AE < Y, which of the following will NOT occur?

A)inventories will decline
B)actual investment will be more than planned investment
C)employment will decline
D)GDP will decline

Question 18

The aggregate expenditure line is upward sloping since as GDP increases,

A)consumption increases
B)investment increases
C)government purchases increase
D)net exports increase

Question 19

The level of potential GDP

A)increases as the real rate of interest decreases.
B)increases as the real rate of interest increases.
C)is unaffected by the real rate of interest.
D)is represented on the IS-MP model by a horizontal line at the world real rate of interest.

Question 20

The capacity of a firm can best be described as:

A)when a firm are producing maximum output
B)a firm's production when operating normal hours using a normal sized workforce
C)when a firm makes full use of all the space available in his factory or building
D)when all of the firm's workers are producing at their maximum potential

Question 21

Economists who have studied the Phillips curve have concluded that it can shift due to all of the following EXCEPT

A)demand shocks.
B)supply shocks.
C)changes in household expectations of inflation.
D)changes in firms' expectations of inflation.

Question 22

What is potential GDP? What happens to unemployment when GDP is at its potential?

Question 23

Use the following data to calculate equilibrium real GDP: C= .75Y, I = $2 trillion, G=$1 trillion and NX = -$0.5 trillion.

Question 24

The relationship between the output gap and the cyclical rate of unemployment is known as

A)the Phillips curve.
B)the LM curve.
C)Murphy's law.
D)Okun's law.

Question 25

What is the inflation gap? What is the output gap?

Question 26

Most economists think changes in which type of unemployment affects inflation?

A)frictional unemployment
B)cyclical unemployment
C)structural unemployment
D)natural rate of unemployment

Question 27

The gap between the current unemployment rate and the natural rate of unemployment is called:

A)frictional unemployment
B)structural unemployment
C)cyclical unemployment
D)full employment

Question 28

The graph of the short-run relationship between the unemployment rate and inflation is called a(n)

A)MP curve.
B)LM curve.
C)IS curve.
D)Phillips curve.

Question 29

All of the following help provide the basis for the Fed controlling the real interest rate in the IS-MP model EXCEPT

A)the Fed controls the federal funds rate through open market operations.
B)if expected future inflation remains stable, changes in nominal interest rates reflect changes in real interest rates.
C)short-term and long-term interest rates tend to move together.
D)the Fed's increased use of TIPS in conducting monetary policy.

Question 30

Explain how does an increase in real interest rates affect the components of AE.

Question 31

Which interest rates is most relevant in determining aggregate expenditures?

A)federal funds rate
B)short-term real interest rate
C)long-term nominal interest rate
D)long-term real interest rate

Question 32

How is the economy likely to respond when AE (sales)exceed production?

Question 33

What is the multiplier effect?

Question 34

What is the difference between an autonomous change in spending and an induced change in spending?

Question 35

In the IS-MP model, when the Fed increases the real interest rate

A)the MP curve shifts up resulting in a decline in the output gap.
B)the MP curve shifts up resulting in an increase in the output gap.
C)the MP curve shifts down resulting in a decline in the output gap.
D)the MP curve shifts down resulting in an increase in the output gap.

Question 36

When the Fed reduces the real interest rate, which of the following does NOT increase?

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

Question 37

The MP curve represents

A)the Fed's monetary policy actions in setting a target for the federal funds rate.
B)the relationship between the money supply and the price level.
C)a relationship between the real interest rate and manufacturing production.
D)the relationship between real interest rates and potential GDP.

Question 38

Which of the following is NOT a reason given by economists for the failure of Okun's law to account for the rise in unemployment during the recession of 2007-2009?

A)increased willingness among firms to lay off workers during recessions
B)a surge in productivity during the recession
C)the unusual severity of the recession
D)it does not take into account the effect of the stimulus

Question 39

How does the goods market return to equilibrium if AE is less than production?

Question 40

What is the multiplier? If MPC =0.75, what is the value of the multiplier in the simple model of the economy?

Question 41

In a closed economy, if the goods market is in equilibrium, national saving is $2 trillion, national consumption is $7 trillion, and government purchases are $2.5 trillion, then GDP equals

A)$7 trillion.
B)$9.5 trillion.
C)$11.5 trillion.
D)Not enough information has been provided to determine the answer.

Question 42

What unusual measures did the Fed take in trying to reduce long-term interest rates during the Financial Crisis of 2007-2009?

A)buying mortgage-backed securities issued by Fannie Mae and Freddie Mac
B)reducing the federal funds rate multiple times
C)issuing its own securities
D)eliminating the discount rate on loans to member banks

Question 43

How can the difference between the current unemployment rate and the natural rate of unemployment help explain changes in inflation?

Question 44

In the bank lending channel, an important reason for output increases in the short run after an expansionary monetary policy is that

A)the funds directly available for households and firms to spend will increase.
B)prices will increase, making increased production more profitable for firms.
C)the increase in government spending from an expansionary monetary policy increases output through the multiplier effect.
D)the ability of banks to make loans will increase.

Question 45

The bank lending channel

A)emphasizes the role of interest rates in the money supply process.
B)emphasizes the importance of borrowers' net worth to the decision of lenders to grant loans.
C)emphasizes the behavior of bank-dependent borrowers.
D)is another name for the interest rate channel.

Question 46

All of the following tends to occur when unemployment is above the natural rate EXCEPT:

A)wage increases will be limited
B)inflation will rise
C)increases in the cost of production will be limited
D)there is slack in the labor market

Question 47

Suppose the stock market crashes resulting in a significant decline in the wealth of consumers. Make use of the IS-MP model to illustrate the impact this has on the economy. How is the Fed likely to respond? Show the impact of the change in monetary policy on the graph of the IS-MP model.

Question 48

Which of the following prevented the Fed from reducing long-term real interest rates during the Financial Crisis of 2007-2009?

A)an increase in expected inflation
B)an increase in the risk premium
C)the collapse in the housing market
D)the failure of the federal funds rate to respond to monetary policy

Question 49

In a closed economy, national saving equals

A)C + I + G.
B)Y - C - G.
C)Y - C - I.
D)Y - G - I.

Question 50

For the goods market to be in equilibrium in a closed economy, which of the following must be true?

A)Y = S + I + G
B)S + I = C + G
C)S + G = Y + C
D)S = I

Question 51

In a closed economy, the total quantity of goods demanded equals the sum of

A)consumption spending, investment spending, and government spending.
B)consumption spending, national saving, and taxes.
C)consumption spending, government spending, and taxes.
D)investment spending, national saving, and taxes.

Question 52

How do expectations of higher inflation become embedded in the economy and affect actual inflation?

Question 53

What happened to the risk premium on Baa corporate bonds during the Financial Crisis of 2007-2009?

A)it declined slightly
B)it rose to about 2%
C)it rose to about 4%
D)it rose to about 6%

Question 54

Which of the following is the least likely take place if the Fed responds to a negative demand shock by reducing the real interest rate?

A)IS shifts to the right
B)output gap returns to zero
C)inflation returns to its previous rate
D)MP shifts down

Question 55

In a closed economy, the goods market is in equilibrium when

A)Y = S + I + G.
B)C + S = I + G.
C)C + I = S + G.
D)Y = C + I + G.

Question 56

A closed economy is one in which

A)investment spending is zero.
B)government spending is zero.
C)there are no imports or exports.
D)demand equals supply in every market.

Question 57

According to the Phillips Curve, which of the following may have taken place if both the unemployment rate and inflation have risen?

A)a negative supply shock
B)an increase in expected inflation
C)a severe recession
D)a negative demand shock

Question 58

How many times is GDP for a particular quarter estimated?

A)once
B)twice
C)three times
D)more than three times

Question 59

All of the following are likely results of a negative demand shock EXCEPT

A)a negative output gap.
B)lower inflation.
C)IS shifts to the left.
D)Phillips curve shifts to the left.

Question 60

What limited the effectiveness of monetary policy during the Financial Crisis of 2007-2009?

Question 61

Which of the following statements is correct?

A)Because in practice few borrowers are bank-dependent, the bank lending channel is of little real-world importance.
B)In the interest rate channel, an expansionary monetary policy may cause a leftward shift in the AD curve.
C)In the bank lending channel, an expansionary monetary policy can increase output in the short run even if it does not result in a decrease in the real interest rate.
D)In the interest rate channel, an expansionary monetary policy affects spending but not output.

Question 62

Lower interest rates which reduce the debt-servicing burden of households, thus increasing their net worth, is best described by the

A)bank lending channel.
B)money channel.
C)financial market channel.
D)balance sheet channel.

Question 63

The balance sheet channel describes ways in which interest rate changes resulting from monetary policy affect

A)the portfolio decisions of households.
B)the portfolio decisions of businesses.
C)borrowers' net worth.
D)lenders' net worth.

Question 64

Which of the following is NOT generally recognized as a channel for monetary policy?

A)interest rate channel
B)balance sheet channel
C)financial market channel
D)bank lending channel

Question 65

How does an expansionary monetary policy affect aggregate expenditures according to the bank lending channel?

Question 66

Monetary policy can have substantial effects on the economy even when nominal interest rates are very low

A)since real rates are what affects borrowing and spending decisions.
B)by improving borrower and bank balance sheets.
C)by reducing transactions costs.
D)only when the policy is substantial.

Question 67

Which of the following is NOT true of the interest rate channel?

A)Bank loans play no special role.
B)The Fed changes the real interest rate which affects the components of aggregate expenditures.
C)Borrowers are indifferent as to how and from whom they raise funds.
D)Alternative sources of funds are not substitutes for each other.

Question 68

A decline in the output gap causes the demand for real balances

A)to rise and the interest rate to fall.
B)to fall and the interest rate to rise.
C)and the interest rate to fall.
D)and the interest rate to rise.

Question 69

Analysts have attempted to model the impact of monetary policy on net worth by emphasizing

A)the impact of lower interest rates on business spending on fixed investment.
B)the impact of lower interest rates on household spending on housing and durable goods.
C)the liquidity of balance sheet positions as a determinant of business and household spending.
D)the greater variability of business spending compared to household spending.

Question 70

An increase in the money supply will cause

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

Question 71

At any point along the LM curve,

A)the quantity of money demanded equals the quantity of money supplied.
B)the economy must be in general equilibrium.
C)the nominal interest rate must equal the real interest rate.
D)saving must equal investment.

Question 72

The LM curve slopes upward to the right because

A)the demand for money plus the demand for nonmoney assets must equal the supply of money plus the supply of nonmoney assets.
B)a higher real interest rate is associated with a higher level of the output gap in money market equilibrium.
C)a higher real interest rate is associated with a higher level of saving in goods market equilibrium.
D)in equilibrium the actual real interest rate must increase one-for-one with expected real interest rate.

Question 73

Changes in net worth and liquidity may significantly affect the volume of lending and economic activity according to the

A)interest rate channel.
B)balance sheet channel.
C)money channel.
D)bank lending channel.

Question 74

An increase in the output gap causes the demand for real balances

A)to rise and the interest rate to fall.
B)to fall and the interest rate to rise.
C)and the interest rate to fall.
D)and the interest rate to rise.

Question 75

The LM curve is the combinations of

A)the output gap and the real interest rate for which the money market is in equilibrium.
B)the inflation rate and nominal interest rate for which the money market is in equilibrium.
C)the inflation rate and real interest rate for which the money market is in equilibrium.
D)the inflation rate and real interest rate for which the goods market is in equilibrium.

Question 76

The ways in which monetary policy affect output and prices are known as:

A)channels
B)stations
C)vehicles
D)means

Question 77

Increases in interest rates

A)reduce borrowers' net worth.
B)reduce lenders' net worth.
C)increase the present value of borrowers' assets.
D)raise the cost to businesses of internal funding.

Question 78

A reduction in the money supply will result in:

A)a lower interest rate and more negative output gap
B)a higher interest rate and more positive output gap
C)a lower interest rate and more positive output gap
D)a higher interest rates and more negative output gap