Deck 24: Linking the Financial System and the Economy: the Is-Lm-Fe Model

Question 1

Purchases and sales of stocks, bonds, and houses take place

A)only in general equilibrium.
B)in the goods market.
C)in the money market.
D)in the nonmoney asset market.

Answer 1

in the nonmoney asset market.

Question 2

Why did the Fed cut interest rates in late 1991?

A)To help reduce the value of the dollar
B)To help increase the value of the dollar
C)To stimulate the economy's recovery from the 1990-1991 recession
D)To help fight inflation

Answer 2

To stimulate the economy's recovery from the 1990-1991 recession

Question 3

An increase in government purchases reduces national saving as long as

A)it causes interest rates to fall.
B)it causes the inflation rate to fall.
C)households' consumption falls less than one-for-one in response.
D)taxes are raised to pay for the spending.

Answer 3

households' consumption falls less than one-for-one in response.

Question 4

Which of the following is NOT a key factor in determining household saving?

A)The expected real rate of interest
B)The level of government purchases
C)Current income
D)Expected future income

Question 5

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 6

In a closed economy, national saving equals

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

Question 7

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 8

A closed economy is one in which

A)investment spending is zero.
B)government spending is zero.
C)there are no international flows of saving and investment.
D)demand equals supply in every market.

Question 9

In macroeconomic models, Y typically represents

A)aggregate wealth.
B)the money supply.
C)gross domestic product (GDP).
D)the income velocity of money.

Question 10

A general equilibrium is an outcome in which

A)all the markets in the economy are in equilibrium at the same time.
B)exports and imports are both zero.
C)the inflation rate is zero.
D)no further economic growth is possible.

Question 11

In the saving-investment diagram, an increase in output will lead to

A)a reduction in saving and a rise in the real interest rate.
B)an increase in saving and a fall in the real interest rate.
C)a reduction in saving and a fall in the real interest rate.
D)an increase in saving and a rise in the real interest rate.

Question 12

In macroeconomic models, Y stands for

A)only aggregate output.
B)only aggregate income.
C)only aggregate output or aggregate income.
D)either aggregate output or aggregate income or the volume of transactions.

Question 13

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 14

Evidence suggests that when government purchases rise

A)national saving rises.
B)consumers reduce their spending dollar for dollar.
C)consumers reduce their spending less than dollar for dollar.
D)the inflation rate falls.

Question 15

An increase in the real interest rate will

A)increase investment demand.
B)decrease the cost of funds for investment.
C)cause businesses to divert funds from investment to the purchase of financial assets.
D)reduce the federal budget deficit.

Question 16

An increase in the expected profitability of investment will cause

A)IS to shift upward.
B)IS to shift downward.
C)LM to shift upward.
D)LM to shift downward.

Question 17

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 18

Why did the Fed cut interest rates in late 1998?

A)To help reduce the value of the dollar
B)To help increase the value of the dollar
C)Fear of the consequences of the Asian financial crisis
D)To offset the effects of low oil prices

Question 19

An increase in the expected real interest rate will have a

A)large negative impact on household saving.
B)large positive impact on household saving.
C)small positive impact on household saving.
D)small negative impact on household saving.

Question 20

The money market includes trade in

A)only currency.
B)only checkable deposits.
C)only currency and checkable deposits.
D)currency, checkable deposits, and other close substitutes for cash.

Question 21

Studies have shown that the degree of international mobility of savings among the United States, Japan, and many European countries

A)has been about the same since the 1960s.
B)declined during the 1980s in comparison to the 1960s and 1970s.
C)increased during the 1980s in comparison to the 1960s and 1970s.
D)has continually declined since the 1960s.

Question 22

At a point above the IS curve,

A)saving exceeds investment.
B)the real interest rate is below its equilibrium level.
C)there is an excess demand for goods.
D)there is a federal budget deficit.

Question 23

The IS curve depicts the relationship between

A)aggregate demand for current 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 24

In a move down the IS curve,

A)saving rises.
B)output falls.
C)the real interest rate rises.
D)the federal budget deficit rises.

Question 25

In a large open economy, the real interest rate does not have to fall by as much in order to restore equilibrium in the goods market in response to an increase in domestic output because

A)the IS curve is steeper.
B)some of the increase in desired domestic saving flows abroad.
C)the increase in desired domestic saving is smaller.
D)foreigners will decrease their demand for domestically produced goods.

Question 26

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 27

In an open economy,

A)the goods market is in equilibrium when domestic saving equals domestic investment.
B)the domestic real interest rate will be below the world real interest rate.
C)the domestic real interest rate will be above the world real interest rate.
D)the goods market is in equilibrium when desired international lending equals desired international borrowing by other countries.

Question 28

The level of full employment output

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-LM-FE diagram by a horizontal line at the world real rate of interest.

Question 29

In the savings-investment diagram, we know that an increase in the real interest rate raises the level of saving because

A)it causes a rightward shift in the investment curve.
B)it causes a leftward shift in the investment curve.
C)the saving curve slopes up.
D)the saving curve slopes down.

Question 30

The intersection of the IS curve and the FE line

A)represents money market equilbrium.
B)determines the equilibrium level of current output and the equilibrium inflation rate.
C)represents goods market equilibrium.
D)determines the equilibrium real interest rate and the equilibrium inflation rate.

Question 31

In comparison with a closed economy, in a large open economy

A)an increase in desired saving will cause a larger decline in the domestic real interest rate.
B)the IS curve will be steeper.
C)an increase in desired investment will cause a smaller increase in the domestic real interest rate.
D)the IS curve will be horizontal at the world real interest rate.

Question 32

In a large open economy,

A)domestic saving need not equal domestic investment.
B)the domestic interest rate must equal the world interest rate.
C)the IS curve will be steeper than in a closed economy.
D)the IS curve will shift only if the FE curve shifts.

Question 33

In a move up the IS curve,

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

Question 34

During the first Gulf War

A)the interest rate rose.
B)current output rose.
C)the IS curve shifted up to the right.
D)the IS curve shifted down to the left.

Question 35

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 36

With respect to the IS curve for a small open economy

A)higher levels of the real interest rate are consistent with higher levels of real output.
B)higher levels of the real interest rate are consistent with lower levels of real output.
C)any value of real output is consistent with the equilibrium real interest rate.
D)any value of the equilibrium real interest rate is consistent with the equilibrium value of real output.

Question 37

At a point below the IS curve,

A)there is an excess supply of goods.
B)there is an excess demand for goods.
C)saving exceeds investment.
D)the real interest rate is above its equilibrium value.

Question 38

At a point below the IS curve,

A)there is an excess supply of goods.
B)the real interest rate is below its equilibrium value.
C)saving exceeds investment.
D)there is a federal budget surplus.

Question 39

The IS curve for a small open economy is

A)steeper than the IS curve for a large open economy.
B)steeper than the IS curve for a closed economy.
C)vertical at the level of full-employment output.
D)horizontal at the world real interest rate.

Question 40

At points not on the IS curve,

A)the federal government's budget must not be balanced.
B)saving must not equal investment.
C)the interest rate must not equal the inflation rate.
D)the demand for money must not equal the supply of money.

Question 41

The FE line would be shifted to the right by

A)a decline in the productivity of labor.
B)a decline in the productivity of capital.
C)an increase in the productivity of labor.
D)a decline in the real interest rate.

Question 42

If the demand for real money balances were infinitely sensitive to the interest rate,

A)the money market would never be in equilibrium.
B)the goods market would never be in equilibrium.
C)the LM curve would be vertical.
D)the LM curve would be horizontal.

Question 43

If the money market is in equilibrium,

A)the inflation rate equals the nominal interest rate.
B)the inflation rate equals the real interest rate.
C)the nonmoney asset market is in equilibrium.
D)the goods market is in equilibrium.

Question 44

If the demand for nonmoney assets exceeds the supply of nonmoney assets, the demand for money

A)must exceed the supply of money.
B)must equal the supply of money.
C)must be less than the supply of money.
D)may be greater than, less than, or equal to the supply of money, depending on prevailing interest rates.

Question 45

At a point above the LM curve,

A)there is an excess demand for money.
B)there is an excess demand for nonmoney assets.
C)the real interest rate is below its equilibrium level.
D)there is an excess demand for goods.

Question 46

The LM curve is the combinations of

A)current output 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 47

Which of the following is the correct expression for the nominal market interest rate?

A)r = i + π^e
B)i = r + π^e
C)r = i π^e
D)i = r π^e

Question 48

Which of the following equations correctly describes equilibrium in the two asset markets?

A)(^Md- ^Nd) + (^Ms -^Ns) = 0
B)(^Md -^Ms) + (^Nd - ^Ns) = 0
C)(^Md + ^Ms) - (^Nd + ^Ns) = 0
D)(^Md - ^Ms) - (^Nd - ^Ns) = 0

Question 49

A change in the inflation rate will

A)not affect the demand for real balances.
B)affect the demand for real balances through its effect on real output.
C)affect the demand for real balances through its effect on the payments system.
D)affect the demand for real balances through its effect on the nominal market interest rate.

Question 50

When the interest sensitivity of the demand for real money balances is low,

A)the LM curve is relatively flat.
B)the IS curve is relatively steep.
C)the LM curve is relatively steep.
D)investment spending will also not be sensitive to the interest rate.

Question 51

An unexpected decrease in oil prices would

A)shift the FE curve to the right.
B)shift the IS curve to the left but leave the FE curve unaffected.
C)shift the FE curve to the left.
D)shift the IS curve to the right but leave the FE curve unaffected.

Question 52

If the demand for money is highly sensitive to the interest rate,

A)the LM curve is relatively flat.
B)the IS curve is relatively steep.
C)the LM curve is relatively steep.
D)investment spending will also be highly sensitive to the interest rate.

Question 53

If the demand for real money balances were completely insensitive to the opportunity cost of holding money,

A)the money market would never be in equilibrium.
B)the goods market would never be in equilibrium.
C)the LM curve would be vertical.
D)the LM curve would be horizontal.

Question 54

A decline in real output 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 55

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 56

The slope of the LM curve is determined by

A)the sensitivity of investment spending to the real interest rate.
B)the gap between the return on money and the market interest rate.
C)the effectiveness of monetary policy.
D)the sensitivity of the demand for real money balances to the nominal interest rate.

Question 57

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 output 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 58

An increase in real output 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 59

Full-employment output can increase for all of the following reasons EXCEPT

A)increased productivity.
B)increased capital stock.
C)increased labor.
D)increase in the price level.

Question 60

At a point below the LM curve,

A)there is an excess supply of money.
B)there is an excess supply of nonmoney assets.
C)the real interest rate is above its equilibrium level.
D)there is an excess supply of goods.

Question 61

An increase in expected inflation will

A)increase the attractiveness of nonmoney assets.
B)decrease the nominal interest rate.
C)shift the LM curve up and to the left.
D)increase the nominal return on money.

Question 62

Which is true concerning the effect of an increase in the money supply compared to general equilibrium?

A)Though it may increase GDP in the short run, its primary effect in general equilibrium is a higher price level.
B)Though it may increase inflation in the short run, its primary effect in general equilibrium is higher GDP.
C)Both GDP and the price level are likely to rise both in the short run and in general equilibrium.
D)Neither GDP nor the price level is likely to be affected in the general equilibrium.

Question 63

A drop in the interest paid on checkable deposits will

A)increase the quantity of real money balances demanded.
B)reduce the real interest rate on nonmoney assets.
C)shift the LM curve down and to the right.
D)shift the IS curve down and to the right.

Question 64

A cut in the federal income tax will cause the IS curve to

A)shift to the left and intersect the FE line at a higher real interest rate.
B)shift to the right and intersect the FE line at a lower real interest rate.
C)shift to the left and intersect the FE line at a lower real interest rate.
D)shift to the right and intersect the FE line at a higher real interest rate.

Question 65

Economists generally believe that prices are

A)always perfectly flexible.
B)always perfectly inflexible.
C)more flexible in the short run than in the long run.
D)more flexible in the long run than in the short run.

Question 66

In the short run, an increase in the money supply will lead to

A)an increase in both GDP and interest rates.
B)an increase in interest rate but a decrease in GDP.
C)a decrease in both GDP and interest rates.
D)an increase in GDP but a decrease in interest rates.

Question 67

When the economy is out of general equilibrium, which curve will adjust to restore general equilibrium?

A)IS
B)LM
C)FE
D)Both IS and LM

Question 68

Which of the following will NOT cause the LM curve to shift to the left?

A)A decrease in supply of nominal money balances
B)A decrease in the aggregate price level
C)An increase in the nominal return on money
D)A decrease in the expected rate of inflation

Question 69

If government purchases decrease, the IS curve will

A)shift to the left and intersect the FE line at a higher real interest rate.
B)shift to the right and intersect the FE line at a lower real interest rate.
C)shift to the left and intersect the FE line at a lower real interest rate.
D)shift to the right and intersect the FE line at a higher real interest rate.

Question 70

Following a decline in the quantity of real money balances supplied, equilibrium is restored in the money market by

A)a rise in the price level.
B)a decline in the price level.
C)a decline in the quantity of money demanded.
D)a decline in the current level of output.

Question 71

Which of the following does NOT necessarily hold when the economy is in long-run equilibrium?

A)Saving equals investment.
B)The nominal interest rate is equal to the real interest rate.
C)The current output supplied is equal to the current output demanded.
D)Households and businesses are willing to accept the mix of money and nonmoney assets they hold.

Question 72

If GDP exceeds its full-employment level in the short run, what will take place to restore general equilibrium?

A)Price level will rise, causing LM to shift upward.
B)Price level will rise, causing LM to shift downward.
C)Price level will fall, causing LM to shift upward.
D)Price level will fall, causing LM to shift downward.

Question 73

Which of the following will NOT cause the LM curve to shift?

A)An increase in the expected inflation rate
B)A decline in the nominal return on money
C)A decline in real output
D)An increase in the aggregate price level

Question 74

An increase in the price level

A)decreases real money balances and shifts the LM curve down and to the right.
B)increases real money balances and shifts the LM curve up and to the left.
C)decreases real money balances and shifts the LM curve up and to the left.
D)increases real money balances and shifts the LM curve down and to the right.

Question 75

If the economy is in general equilibrium and the Fed reduces the money supply,

A)the previous equilibrium combination of output and the real interest rate represents a point of excess demand for money.
B)the previous equilibrium combination of output and the real interest rate represents a point where saving is greater than investment.
C)the LM curve shifts down and to the right.
D)the level of investment spending will increase.

Question 76

An increase in labor productivity will cause the FE line to

A)shift to the left.
B)intersect the IS curve at a higher real interest rate.
C)intersect the LM curve at a higher real interest rate.
D)become steeper.

Question 77

In general equilibrium, an increase in the money supply leads to

A)lower interest rates.
B)higher GDP.
C)higher price level.
D)higher interest rates.

Question 78

At a point above the LM curve,

A)there is an excess demand for money.
B)there is an excess supply of nonmoney assets.
C)the real interest rate is above its equilibrium level.
D)there is an excess demand for goods.

Question 79

An increase in the supply of real money balances 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 80

An increase in the nominal return on money

A)shifts the LM curve up and to the left.
B)shifts the LM curve down and to the right.
C)will increase the real interest rate on nonmoney assets.
D)shift the IS curve down and to the right.