Question 1

With a fixed supply of money, as GDP rises, the demand for money ____ and therefore ____ must rise to encourage savers to hold financial assets instead of cash.

Accepted Answer

As GDP rises, the demand for money rises. This is because there is an increased demand for financial assets, such as stocks and bonds, due to businesses and individuals having more money to invest. To encourage savers to hold financial assets instead of cash, the rates of interest must rise. This will make holding financial assets more attractive, thereby decreasing the demand for money.

Question 2

Changing the rate at which the central bank makes loans counts as:

Accepted Answer

Changing the rate at which the central bank makes loans is a tool used by the central bank to influence the supply of money in the economy. This is known as monetary policy. Fiscal policy refers to actions taken by the government to influence the economy, such as changes in taxation and government spending. Therefore, changing the rate at which the central bank makes loans is not fiscal policy.

Question 3

If the demand for money increases, what happens in the IS-LM framework?

Accepted Answer

An increase in the demand for money means that people want to hold more money relative to other assets. This causes the price of holding money (i.e. interest rate) to increase, which shifts the LM curve to the left. The IS curve remains unchanged because the demand for goods and services is not affected by the increase in the demand for money. Therefore, the correct answer is D, the LM curve shifts left.

Question 4

The LM curve describes the relationship between interest rates and GDP for which the supply of money is equal to the demand for real balances, holding _____ constant.

Accepted Answer

The LM curve is derived from the equation for the demand for real money balances, which is impacted solely by the quantity of money in circulation. Therefore, choice C, "the quantity of money," is the only factor held constant in the LM curve. Choices A and B, "expectations" and "tastes and preferences," respectively, are not taken into account in the construction of the LM curve. Furthermore, choice D, "expectations, tastes, and the quantity of money," is not applicable, as expectations and tastes are not considered in the equation for the demand for real money balances.

Question 5

The LM curve shows equilibrium in the _______ market at various levels of interest rates and GDP.

Accepted Answer

The LM curve shows equilibrium in the money market at various levels of interest rates and GDP. The curve represents the combinations of interest rates and output levels at which the demand for money equals the supply of money, establishing the equilibrium in the money market.

Question 6

Consider an economy with flexible exchange rates. If there are high levels of inflation in the economy, then the appropriate monetary policy would be to ________ the money supply, which will cause the ______ curve to shift ________.

Accepted Answer

If there are high levels of inflation in the economy, then the appropriate monetary policy would be to decrease the money supply. This will cause a contraction in output, hence causing the LM curve to shift leftward.

Question 7

A government policy deemed to be "temporary" indicates:

Accepted Answer

A temporary government policy implies that agents in the economy do not adjust their long-term expectations based on the policy, assuming it will not last long enough to warrant changes in long-term contracts or plans. This includes keeping expectations about exchange rates and other economic variables constant in the long run, while in the short run, prices may not adjust immediately due to stickiness, leading to temporary economic effects.

Question 8

All else being equal, an increase in government spending would shift the ______ line to the ______, causing interest rates to _______ and the trade balance to _______.

Accepted Answer

An increase in government spending shifts the IS curve to the right, leading to higher interest rates due to increased demand for funds. This, in turn, appreciates the domestic currency, reducing exports and increasing imports, thus worsening the trade balance.

Question 9

Consider the IS-LM curves for an economy with flexible exchange rates. An increase in the foreign income will result in the:

Accepted Answer

An increase in foreign income will lead to an increase in demand for the domestic country's goods, which will increase the aggregate demand (AD) for the domestic country. This will result in a rightward shift of the IS curve as higher AD leads to higher output and higher interest rates. The LM curve will not be affected by an increase in foreign income as the exchange rate is flexible, meaning that the domestic currency will adjust to maintain equilibrium in the money market.

Question 10

After identifying one combination of interest rates and GDP for which the demand for money is equal to the supply of money (equilibrium), to maintain the equilibrium if GDP rises:

Accepted Answer

When GDP rises, typically, the demand for money increases as businesses and consumers spend more. To maintain the equilibrium between the demand for money and the supply of money, interest rates would have to rise. Higher interest rates can temper the demand for money, bringing it back into equilibrium with the supply.

Question 11

The direction of change in the trade balance is uncertain because expansionary monetary policy may exert forces in the opposite direction. What are they?

Accepted Answer

An expansionary monetary policy typically leads to lower interest rates, which can depreciate the domestic currency, making exports cheaper and imports more expensive, potentially improving the trade balance. However, the same policy can also increase domestic income, leading to higher import demand and potentially worsening the trade balance. Thus, these opposing forces create uncertainty in the direction of change in the trade balance.

Question 12

If the central bank expands the money supply under floating exchange rates, it potentially stimulates the economy in two ways, namely:

Accepted Answer

When the central bank expands the money supply under floating exchange rates, it lowers the rate of interest, which can encourage borrowing and investment, leading to economic growth. Additionally, this can cause a depreciation of the currency, making exports cheaper and more attractive to foreign buyers, leading to increased competition and economic growth. Option A is incorrect because while expansion of the money supply can raise the price level (inflation), it does not necessarily create increased competition. Option C is incorrect because increasing the budget deficit has no direct effect on stimulating the economy. Option D is incorrect because while increased worker productivity and R&D incentives may contribute to long-term economic growth, they are not direct results of expanding the money supply.

Question 13

If the LM curve shifts down, this would be consistent with:

Accepted Answer

The LM curve shows the combinations of interest rates and output levels at which the money market is in equilibrium. A downward shift in the LM curve means that for any given level of output, the interest rate is lower. This can happen if there is an increase in the money supply, as there is more money available to borrow and lend, and lenders may therefore offer lower interest rates in order to be competitive.

Question 14

If the demand for money decreases, ceteris paribus, the LM curve would:

Accepted Answer

A decrease in demand for money means that people want to hold less money for transactions, implying a greater willingness to lend or invest. This leads to a decrease in the interest rate at every level of income, causing the LM curve to shift leftward.

Question 15

Increasing the transfers from workers to the unemployed counts as:

Accepted Answer

The answer of Increasing the transfers from workers to the...

Question 16

The LM curve will shift to the right, if there is a(n):

Accepted Answer

An increase in money supply will cause interest rates to fall, leading to an increase in investment and consumption spending, thereby increasing output. As a result, the LM curve will shift to the right. A decrease in money supply (choice A) would cause interest rates to rise and output to decrease, shifting the LM curve to the left. An increase in real money demand (choice B) would have no effect on the position of the LM curve, but would instead cause a movement along the LM curve to a higher interest rate level. Finally, an increase in output (choice D) would shift the IS curve, but would have no direct impact on the position of the LM curve.

Question 17

If the supply of money increases, what happens in the IS-LM framework?

Accepted Answer

In the IS-LM framework, an increase in the supply of money leads to a decrease in the interest rate. This, in turn, increases the demand for goods and services, leading to an increase in output and a shift in the LM curve to the right. The IS curve remains unchanged. Therefore, the correct answer is B.

Question 18

When exchange rates are fixed, a temporary expansion in the money supply will:

Accepted Answer

When exchange rates are fixed, a temporary expansion in the money supply will have no effect on the exchange rate. However, it will not increase output either as it is a temporary expansion and not a permanent one. Therefore, output will remain unchanged.

Question 19

It can be shown using the IS-LM-FX model that a temporary expansion in the supply of money is effective in:

Accepted Answer

In the IS-LM-FX model, a temporary expansion in the money supply shifts the LM curve to the right. This leads to lower interest rates and higher output, thus combating temporary downturns in the economy. Option A is incorrect as it is the opposite of what happens in the model. Option B and D are unrelated to the effects of a temporary expansion in the supply of money.

Question 20

If we start from long-run general equilibrium of goods, forex, and the money markets, and there is a temporary expansion of the money supply, what will be the outcome?

Accepted Answer

In the short run, an expansion of the money supply lowers interest rates, which stimulates investment and increases GDP. Lower interest rates also lead to a depreciation of the exchange rate as capital flows out in search of higher returns elsewhere.

Quiz 18: Balance of Payments II: Output, Exchange Rates, and Macroeconomic Policies in the Short Run

With a fixed supply of money, as GDP rises, the demand for money and therefore must rise to encourage savers to hold financial assets instead of cash.