Question 1

Suppose Congress passes legislation that significantly reduces taxes. Use the Keynesian-cross model to illustrate graphically the impact of a reduction in taxes 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 tax cut and the time horizon appropriate for this analysis.

Accepted Answer

The answer of Suppose Congress passes legislation that significantly reduces...

Question 2

Equilibrium levels of income and interest rates are related in the goods and services market, and equilibrium levels of income and interest rates are related in the market for real money balances.
A)positively; positively
B)positively; negatively
C)negatively; negatively
D)negatively; positively

Accepted Answer

In the goods and services market, higher levels of income lead to an increase in demand for goods and services, which in turn leads to an increase in the demand for money. As a result, the demand for money exceeds the supply of money, creating an excess demand for money. To eliminate this excess demand for money, interest rates must rise, so equilibrium levels of income and interest rates are negatively related in the goods and services market.

In the market for real money balances, higher levels of income lead to an increase in the demand for money. As a result, the demand for money exceeds the supply of money, creating an excess demand for money. To eliminate this excess demand for money, interest rates must rise, so equilibrium levels of income and interest rates are positively related in the market for real money balances.

Question 3

Consider a closed economy to which the Keynesian-cross analysis applies. Consumption is given by the equation C = 200 + 2/3(Y - T). Planned investment is 300, as are government spending and taxes.
a. If Y is 1,500, what is planned spending? What is inventory accumulation or decumulation?
Should equilibrium Y be higher or lower than 1,500?
b. What is equilibrium Y? (Hint: Substitute the values of equations for planned consumption, investment, and government spending into the equation Y = C + I + G and then solve for Y.) c. What are equilibrium consumption, private saving, public saving, and national saving?
d. How much does equilibrium income decrease when G is reduced to 200? What is the
multiplier for government spending?

Accepted Answer

The answer of Consider a closed economy to which the...

Question 4

Assume that the consumption function is given by C = 200 + 0.5(Y - T) and the investment function is I = 1,000 - 200r, where r is measured in percent, G equals 300, and T equals
200.
a. What is the numerical formula for the IS curve? (Hint: Substitute for C, I, and G in the equation Y = C + I + G and then write an equation for Y as a function of r or r as a function of Y.) Express the equation two ways.
b. What is the slope of the IS curve? (Hint: The slope of the IS curve is the coefficient of Y
when the IS curve is written expressing r as a function of Y.)
c. If r is one percent: what is I? what is Y? If r is 3 percent: what is I? what is Y? If r is 5 percent: what is I? what is Y?
d. If G increases, does the IS curve shift upward and to the right or downward and to the left?

Accepted Answer

The answer of Assume that the consumption function is given...

Question 5

In the Keynesian-cross analysis, if the consumption function is given by C = 100 + 0.6(Y - T), and planned investment is 100, G is 100, and T is 100, then equilibrium Y is:
A)350.
B)400.
C)600.
D)750.

Accepted Answer

In the Keynesian-cross model, equilibrium output (Y) is where planned expenditure equals actual output. The planned expenditure is C + I + G. Substituting the given values: C = 100 + 0.6(Y - 100), I = 100, G = 100. So, planned expenditure = 100 + 0.6(Y - 100) + 100 + 100. Setting this equal to Y and solving gives Y = 600.

Question 6

Assume that the money demand function is (M/P)d = 2,200 - 200r, where r is the interest rate in percent. The money supply M is 2,000 and the price level P is 2. If the price level is fixed and the Fed wants to fix the interest rate at 7 percent, it should set the money supply at:
A)2,000.
B)1,800.
C)1,600.
D)1,400.

Accepted Answer

To fix the interest rate at 7 percent, the Fed needs to set the money supply at the level where the quantity of money demanded equals the quantity of money supplied at 7%.

(M/P)d = (M/P)s at r = 7%
2200 - 200(7) = (2000/2) = 1000
1200 = (M/P)s at r = 7%
(M/P)s = 1200/2 = 600

So the Fed needs to increase the money supply to 1,600 to meet the demand for money at a 7% interest rate.

Question 7

Consider the impact of an increase in thriftiness in the Keynesian-cross analysis. Assume that the marginal propensity to consume is unchanged, but the intercept of the consumption function is made smaller so that at every income level saving is greater. This will:
A)increase saving by the decrease in the intercept.
B)lead to no change in saving.
C)decrease saving by the decrease in the intercept.
D)lead to an increase in investment.

Accepted Answer

An increase in thriftiness in the Keynesian-cross analysis, characterized by a decrease in the intercept of the consumption function, directly increases saving by the amount of the decrease in the intercept. This is because, at every level of income, individuals are choosing to save more and consume less, leading to an increase in saving by the decrease in the intercept.

Question 8

Consider the impact of an increase in thriftiness in the Keynesian-cross analysis. Assume that the marginal propensity to consume is unchanged, but the intercept of the consumption function is made smaller so that at every income level saving is greater. This will:
A)lower equilibrium income by the decrease in the intercept multiplied by the multiplier.
B)lower equilibrium income by the decrease in the intercept.
C)raise equilibrium income by the decrease in the intercept.
D)raise equilibrium income by the decrease in the intercept multiplied by the multiplier.

Accepted Answer

In the Keynesian-cross analysis, an increase in thriftiness, represented by a decrease in the intercept of the consumption function, means that at every level of income, consumption is lower and saving is higher. This decrease in consumption reduces aggregate demand, leading to a lower equilibrium income. The effect on equilibrium income is amplified by the multiplier, which is determined by the marginal propensity to consume (which remains unchanged in this scenario). Therefore, the equilibrium income is lowered by the decrease in the intercept multiplied by the multiplier.

Question 9

The IS curve provides combinations of interest rates and income that satisfy equilibrium in the market for , and the LM curve provides combinations of interest rates and income that satisfy equilibrium in the market for .
A)saving and investment; planned spending
B)real-money balances; loanable funds
C)goods and services; real-money balances
D)real-money balances; goods and services

Accepted Answer

The IS curve represents equilibrium in the goods and services market, where investment equals saving, while the LM curve represents equilibrium in the money market, where demand for and supply of real money balances are equal.

Question 10

In the Keynesian-cross analysis, assume that the analysis of taxes is changed so that taxes, T, are made a function of income, as in T = T + tY, where T and t are parameters of the tax
Code and t is positive but less than 1. As compared to a case where t is zero, the multiplier for government purchases in this case will:
A)not change.
B)be smaller.
C)be bigger.
D)be equal to 1.

Accepted Answer

When taxes are a function of income, the marginal propensity to consume out of disposable income decreases, leading to a smaller multiplier effect for government purchases.

Question 11

According to the Keynesian-cross analysis, if the marginal propensity to consume is 0.6, and government expenditures and autonomous taxes are both increased by 100, equilibrium income will rise by:
A)0.
B)100.
C)150.
D)250.

Accepted Answer

The answer of According to the Keynesian-cross analysis, if the...

Question 12

Assume that the money demand function is (M/P)d = 2,200 - 200r, where r is the interest rate in percent. The money supply M is 2,000 and the price level P is 2. The equilibrium interest rate is percent.
A)2
B)4
C)6
D)8

Accepted Answer

The answer of Assume that the money demand function is...

Question 13

Assume that the money demand function is (M/P)d = 2,200 - 200r, where r is the interest rate in percent. The money supply M is 2,000 and the price level P is 2. If the price level is fixed and the supply of money is raised to 2,800, then the equilibrium interest rate will:
A)drop by 4 percent.
B)drop by 2 percent.
C)drop by 1 percent.
D)remain unchanged.

Accepted Answer

Using the money market equilibrium formula: (M/P)d = M/P, we can solve for the initial equilibrium interest rate:
(2,200 - 200r)/2 = 2,000/2
2,200 - 200r = 2,000
-r = -1
r = 1%

With a money supply of 2,800 and the price level fixed at 2, the new equilibrium interest rate can be found by setting the new quantity of money equal to the original money demand function, and solving for r:
(2,200 - 200r)/2 = 2,800/2
2,200 - 200r = 2,800
-r = -3
r = 3%

Therefore, the equilibrium interest rate will drop by 2 percent (from 1% to 3%). The correct answer is B.

Question 14

Compare how equilibrium is attained in the market for goods and services versus the market for real-money balances. (Hint: Explain what force moves the market back to equilibrium if the market is initially in disequilibrium.)

Accepted Answer

The answer of Compare how equilibrium is attained in the...

Question 15

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.

Accepted Answer

The IS-LM model is generally used in the short run to analyze the relationship between real output and interest rates under different levels of government spending, taxes, and money supply.

Question 16

Suppose Congress decides to reduce the budget deficit by cutting government spending. Use 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.

Accepted Answer

The answer of Suppose Congress decides to reduce the budget...

Question 17

In explaining the 2003 bill to cut taxes, President Bush is quoted as saying, "When people have more money, they can spend it on goods and services."
a. In the IS-LM model, will a tax cut change the money supply in the economy? Does a
change in the money supply shift the IS or the LM curve?
b. In the IS-LM model, does a tax cut shift the IS or the LM curve?
c. Based on your Answer s in a and b, how can you reconcile the president's statement with economics? Can you suggest how his statement could be modified to be consistent with the IS-LM model?

Accepted Answer

The answer of In explaining the 2003 bill to cut...

Question 18

Assume that the equilibrium in the money market may be described as M/P = 0.5Y - 100r, and M/P equals 800.
a. Write the LM curve two ways, expressing Y as a function of r and r as a function of Y. (Hint: Write the LM curve only relating Y and r; substitute out M/P.)
b. What is the slope of the LM curve?
c. If r is 1 percent, what is Y along the LM curve? If r is 3 percent, what is Y along the LM
curve? If r is 5 percent, what is Y along the LM curve?
d. If M/P increases, does the LM curve shift upward and to the left or downward and to the right?
e. If M increases and P is constant, does the LM curve shift upward and to the left or
downward and to the right?
f. If P increases and M is constant, does the LM curve shift upward and to the left or downward and to the right?

Accepted Answer

The answer of Assume that the equilibrium in the money...

Question 19

Two identical countries, Country A and Country B, can each be described by a Keynesian-cross model. The MPC is 0.9 in each country. Country A decides to increase spending by $2 billion, while Country B decides to cut taxes by $2 billion. In which country will the new equilibrium level of income be greater?

Accepted Answer

The answer of Two identical countries, Country A and Country...

Question 20

The interest rate affects which variable in the market for goods and services versus the market for real money balances?
b. The level of income affects which variable in the market for goods and services versus the market for real money balances?

Accepted Answer

The answer of The interest rate affects which variable in...

Quiz 10: Aggregate Demand I: Building the Is-Lm Model

Equilibrium levels of income and interest rates are related in the goods and services market, and equilibrium levels of income and interest rates are related in the market for real money balances.

In the Keynesian-cross analysis, if the consumption function is given by C = 100 + 0.6(Y - T) , and planned investment is 100, G is 100, and T is 100, then equilibrium Y is:

Assume that the money demand function is (M/P) d = 2,200 - 200r, where r is the interest rate in percent. The money supply M is 2,000 and the price level P is 2. If the price level is fixed and the Fed wants to fix the interest rate at 7 percent, it should set the money supply at:

Consider the impact of an increase in thriftiness in the Keynesian-cross analysis. Assume that the marginal propensity to consume is unchanged, but the intercept of the consumption function is made smaller so that at every income level saving is greater. This will:

Consider the impact of an increase in thriftiness in the Keynesian-cross analysis. Assume that the marginal propensity to consume is unchanged, but the intercept of the consumption function is made smaller so that at every income level saving is greater. This will:

The IS curve provides combinations of interest rates and income that satisfy equilibrium in the market for , and the LM curve provides combinations of interest rates and income that satisfy equilibrium in the market for .

According to the Keynesian-cross analysis, if the marginal propensity to consume is 0.6, and government expenditures and autonomous taxes are both increased by 100, equilibrium income will rise by:

Assume that the money demand function is (M/P) d = 2,200 - 200r, where r is the interest rate in percent. The money supply M is 2,000 and the price level P is 2. The equilibrium interest rate is percent.

Assume that the money demand function is (M/P) d = 2,200 - 200r, where r is the interest rate in percent. The money supply M is 2,000 and the price level P is 2. If the price level is fixed and the supply of money is raised to 2,800, then the equilibrium interest rate will:

Compare how equilibrium is attained in the market for goods and services versus the market for real-money balances. (Hint: Explain what force moves the market back to equilibrium if the market is initially in disequilibrium.)

The IS-LM model is generally used:

The interest rate affects which variable in the market for goods and services versus the market for real money balances? b. The level of income affects which variable in the market for goods and services versus the market for real money balances?