Deck 8: Financial Markets and Aggregate Demand

Question 1

Which of the following is part of the explanation of why net exports are correlated with interest rates?

A) An increase in domestic interest rates discourages foreign lending.
B) A reduction in foreign lending drives up the value of the domestic currency.
C) An increase in the value of the domestic currency increases the demand for foreign goods.
D) An increase in the demand for foreign goods causes an immediate increase in net exports.
E) None of the above is both an accurate statement and part of an explanation of the correlation between net exports and interest rates.

Answer 1

An increase in the value of the domestic currency increases the demand for foreign goods.

Question 2

Let I = e - dR represent an investment function. The coefficient d

A) should always be positive and larger in magnitude if a 1-point increase in R causes a relatively large change in investment.
B) should always be negative and larger in magnitude if a 1-point increase in R causes a relatively large change in investment.
C) should always be positive and smaller in magnitude if a 1-point increase in R causes a relatively large change in investment.
D) should always be negative and smaller in magnitude if a 1-point increase in R causes a relatively large change in investment.
E) can have either sign depending on circumstance.

Answer 2

should always be positive and larger in magnitude if a 1-point increase in R causes a relatively large change in investment.

Question 3

All points on the IS curve represent combinations of interest rates and GDP supported by the condition that

A) the sum of private and public saving falls short of investment by an amount equal to the multiplier.
B) the sum of private and public saving just equals investment.
C) the sum of private and public saving exceeds investment by an amount equal to the multiplier.
D) the demand for money matches the supply of money.
E) the supply of money just finances the quantity of investment that people intend to undertake.

Answer 3

the sum of private and public saving just equals investment.

Question 4

The price level in the long-run model

A) is positively related to the level of real GDP.
B) is positively related to the interest rate.
C) is positively related to the sensitivity of money demand to income.
D) is negatively related to the sensitivity of money demand to the interest rate.
E) none of the above.

Question 5

Let total spending be notationally represented by A + bY + cR + dG. Which of the following correctly identifies the signs of the parameters A, b, c, and d?

A) All the parameters are positive.
B) All the parameters are negative.
C) Parameter A is positive, but all the lowercase parameters are negative.
D) All the parameters but c are positive; c is negative.
E) All the parameters but b are negative; b is positive.

Question 6

The demand for money

A) varies positively with the interest rate.
B) varies positively with GDP.
C) varies negatively with the price level.
D) varies positively with the Dow-Jones stock price index.
E) all of the above.

Question 7

Capital asset pricing models serve as an important tool for stock market analysts because

A) normal people cannot understand them.
B) they would otherwise not be able to price stocks.
C) they tell analysts which stocks and bonds have the strongest earnings potential.
D) require analysts to think about only risk-free and expected portfolio rates of return.
E) guarantee the construction of profitable financial portfolios.

Question 8

Net exports are

A) positively correlated with both interest rates and GDP.
B) positively correlated with interest rates but fairly independent of GDP.
C) positively correlated with GDP but fairly independent of interest rates.
D) negatively correlated with GDP but positively correlated with interest rates.
E) negatively correlated with both interest rates and GDP.

Question 9

The relationship between changes in interest rates and changes in GDP

A) is negative since increases in R decrease investment.
B) is negative since increases in R decrease net exports.
C) cannot be determined since both variables are determined endogenously.
D) is positive since increases in R increase investment.
E) a and b.

Question 10

Suppose that the supply of money were fixed and GDP rose. To maintain the equality of supply and demand in the money market,

A) interest rates would have to fall if prices are to be held stable.
B) the price level would have to rise if interest rates are to be held constant.
C) interest rates would have to rise if prices are to be held stable.
D) nothing else would have to happen.
E) prices and interest rates would both have to fall.

Question 11

The money demand equation found in Chapter 8 uses the letters k and h.
They

A) are variables.
B) are coefficients.
C) stay fixed.
D) a and c.
E) b and c.

Question 12

Given a nominal rate of interest, the real rate of interest can be computed by

A) multiplying the nominal rate by a price index for the year being studied.
B) subtracting the rate of growth of the economy.
C) subtracting the expected rate of growth of prices in the future.
D) multiplying the nominal rate by the ratio of contemporaneous inflation and unemployment.
E) none of the above.

Question 13

Financial variables include, for the purposes of macroeconomic modeling,

A) the supply of money.
B) the quantity of investment.
C) the rate of interest.
D) b and c.
E) a and c.

Question 14

In the long run, an increase in the rate of growth in the money stock

A) increases the rate of inflation in the economy.
B) increases the level of GDP in the economy.
C) increases the amount of investment in the economy.
D) reduces net exports in the economy.
E) none of the above.

Question 15

Using R to represent an average interest rate is

A) an acceptable practice in the short run, because all interest rates on many different types of securities tend to move up and down together.
B) a questionable practice in the short run, because securities with different risks pay different returns.
C) a questionable practice in the long run, because term structure variations between short- and longer-term rates can be important.
D) an acceptable practice in the long run, because short- and long-term rates on most securities tend to move in tandem.
E) a and c.

Question 16

Capital asset pricing models assist stock market analysts by

A) focusing on a single, risk-free interest rate.
B) ignoring popular reliance on arbitrage profits.
C) assuming the absence of arbitrage profits.
D) a and b.
E) a and c.

Question 17

In theory, the relationship between interest rates and stock market returns

A) helps explain stock price movements but not derivative price movements.
B) has been the focal point of only a few fringe economists.
C) has been explored primarily using descriptive statistical methods.
D) has been the focus of Noble Prize-winning economists Markowitz, Miller, and Sharpe.
E) has remained a theoretical abstraction.

Question 18

The investment function reflects a negative relationship between the quantity of investment and the interest rate because

A) high interest rates make the borrowing that some require to finance investment too expensive relative to the potential return.
B) high interest rates make the opportunity cost of foregoing an interest rate return on funds in lieu of financing an investment too high.
C) low interest rates mean that more investment projects are available that pay the superior returns financiers are looking for.
D) all of the above.
E) none of the above.

Question 19

In the long run, an increase in the stock of money

A) increases the rate of inflation in the economy.
B) increases the level of GDP in the economy.
C) increases the amount of investment in the economy.
D) reduces net exports in the economy.
E) none of the above.

Question 20

Just like the nominal demand for money, the real demand for money

A) varies positively with the quantity of investment.
B) varies positively with the interest rate.
C) varies negatively with GDP.
D) varies negatively with the interest rate.
E) varies not at all with the price level.

Question 21

If the LM curve were vertical, then an increase in government spending or a reduction in taxes would

A) do nothing but increase GDP and leave interest rates fixed.
B) do nothing but increase interest rates, so that the resulting reduction in investment would exactly cancel the stimulative effects of either fiscal policy.
C) increase interest rates a bit but still generate some small increase in GDP.
D) stimulate growth in GDP only if it were accompanied by an increase in the money supply.
E) none of the above.

Question 22

If people were suddenly to begin to save a larger proportion of their after-tax income, we should expect to see

A) the IS curve getting steeper.
B) the LM curve getting steeper.
C) the IS curve getting flatter.
D) the LM curve getting flatter.
E) none of the above.

Question 23

The LM curve is really an algebraic or graphic representation of all the combinations of interest rates and GDP that support

A) equality between investment and the sum of private and public saving.
B) equality between supply and demand in the markets for goods and services across the economy.
C) equality between supply and demand in the money market.
D) the expectations of both the Federal Reserve System Board of Governors and the President's Council of Economic Advisers.
E) all of the above.

Question 24

Suppose that the goal of policy were to increase GDP without putting upward pressure on interest rates. If the IS-LM construction displayed the usual slopes, then an appropriate mix of policies would be

A) a reduction in the money supply coupled with a reduction in government spending.
B) an increase in government spending, a reduction in taxes, and an increase in the supply of money.
C) a reduction in the supply of money coupled with an increase in taxation.
D) an increase in government spending coupled with some strict price controls that would fix the price level at the original level.
E) none of the above.

Question 25

Suppose that net exports were to become more sensitive to changes in the interest rate. You would reflect this change by drawing

A) steeper LM curves.
B) flatter LM curves.
C) steeper IS curves.
D) flatter IS curves.
E) IS and LM curves exactly as before.

Question 26

It has been argued by some that, "An increase in defense spending will cause GDP to fall because the resulting higher interest rates will depress investment." What is wrong with that argument?

A) Higher interest rates may depress investment, but that is a consequence of an increase in aggregate demand and thus GDP; GDP, therefore, will not fall.
B) Every increase in defense spending is accompanied by an increase in tax receipts, so there is no interest rate increase to depress investment.
C) Defense spending is not part of aggregate demand and thus has no effect on GDP.
D) Higher interest rates stimulate investment; the sign of the effect is wrong.
E) None of the above; the statement is true.

Question 27

IS-LM analysis represents

A) monetary policy by a shift in the LM curve and fiscal policy by a shift in the IS curve.
B) monetary policy by a shift in the IS curve and fiscal policy by a shift in the LM curve.
C) fiscal and monetary policies by opposite shifts in the IS curve.
D) fiscal and monetary policies by opposite shifts in the LM curve.
E) none of the above.

Question 28

Every point of intersection between an IS schedule and an LM curve can be characterized as specifying

A) a point on an aggregate demand curve for the underlying, predetermined price level.
B) a combination of interest rate and GDP such that the demand for money is equal to the supply of money.
C) an interest rate-GDP combination such that the consumption function, investment function, and income identity are all satisfied for a particular government spending-taxation combination.
D) an equilibrium combination of interest rates and GDP for both the goods market and the money market.
E) all of the above.

Question 29

The slope of an LM curve

A) gets steeper the more responsive the demand for money is to changes in GDP.
B) gets flatter the more responsive the demand for money is to changes in the interest rate.
C) is invariant, in the simple case at least, to small changes in the price level.
D) is invariant to policy shifts in the supply of money, unless the sensitivity of the demand for money to changes in GDP or interest rates is affected.
E) all of the above.

Question 30

The IS curve is, in part,

A) downward sloping because of the inverse relationship between investment and the interest rate; it is steeper the stronger is that relationship.
B) downward sloping because of the inverse relationship between the demand for money and the interest rate; it is flatter the stronger is that relationship.
C) downward sloping because of the positive relationship between disposable income and consumption; it is steeper the larger is the marginal propensity to consume.
D) upward sloping because of the positive relationship between the demand for money and the price level; it is steeper the stronger is that relationship.
E) a and c.

Question 31

In the IS-LM model, changes in government purchases lead to larger changes in GDP if

A) the IS curve is flatter due to a larger value of the marginal propensity to consume.
B) money demand becomes less sensitive to the interest rate.
C) they are offset by increases in taxes.
D) the LM curve becomes steeper.
E) none of the above.

Question 32

Consider a $10 billion increase in government spending and investment. The IS curve

A) shifts to the right to reflect their combined stimulus.
B) shifts to the right, for any interest rate, a distance equal to the multiplier times $10 billion times 2 to reflect first the stimulus of government spending and second that of the increased investment.
C) shifts to the right in parallel unless the responsiveness of investment to changes in the interest rate were to change.
D) shifts to the right and gets flatter if the stimulus caused investment to become more sensitive to changes in the interest rate.
E) all of the above.

Question 33

An increase in the price level causes

A) the LM curve to shift to the right.
B) the LM curve to shift to the left.
C) the IS curve to shift to the right.
D) the IS curve to shift to the left.
E) no change in an IS-LM representation of an economy.

Question 34

Which of the following statements is part of an accurate explanation of how an increase in the value of the dollar could lead to a reduction in GDP in the United States?

A) As the value of the dollar climbs, so do net exports.
B) Higher net exports produce lower interest rates by movement along an LM curve.
C) Movement along an LM curve toward lower interest rates corresponds to lower levels of GDP.
D) All of the above are accurate parts of the explanation.
E) None of the above can be an accurate part of the explanation, because the statement is false.

Question 35

In the IS-LM model, changes in government purchases lead to larger changes in GDP if

A) money demand becomes less sensitive to GDP.
B) money demand becomes less sensitive to the interest rate.
C) they are offset by increases in taxes.
D) the LM curve becomes steeper.
E) none of the above.

Question 36

In the IS-LM model, GDP becomes more sensitive to changes in the supply of money if

A) investment becomes less sensitive to the interest rate.
B) the marginal propensity to import increases.
C) the marginal propensity to import decreases.
D) net exports become less sensitive to the interest rate.
E) the marginal propensity to consume decreases.

Question 37

Which of the following would be included in the computation of the money supply?

A) Cash held in a child's piggy bank
B) Ted Turner's holdings of TBS stock
C) An insurance company's holdings of mutual fund shares
D) An investor's holding of money market certificates
E) A college student's credit card limit

Question 38

With a positively sloped LM curve, the increase in GDP resulting from an increase in government spending

A) is larger than the usual multiplier effect because the resulting lower interest rates promote a secondary expansion in investment activity.
B) is smaller than the usual multiplier effect because the government has to reduce the money supply to pay for its new spending.
C) is larger than the usual multiplier effect because the corresponding increase in the money supply provides a second stimulative effect.
D) is smaller than the usual multiplier effect because the resulting higher interest rates cause a secondary contraction in investment activity.
E) none of the above.

Question 39

If both investment and net exports are totally insensitive to changes in the interest rate, then

A) the IS curve is horizontal.
B) the IS curve is vertical.
C) the LM curve is horizontal.
D) the LM curve is vertical.
E) the IS curve is horizontal and the LM curve is vertical; a unique equilibrium pair R*, Y*) is thereby defined unambiguously.

Question 40

Suppose you were given an equilibrium interest rate and a price level consistent with the equality of supply and demand in both the money market and the aggregate goods and services market. You could then

A) compute the corresponding level of GDP only by plugging the given interest rate into the LM curve and solving for Y*.
B) compute the corresponding level of GDP only by plugging the given interest rate into the IS curve and solving for Y*.
C) compute the corresponding level of GDP by plugging the given interest rate into either the IS curve or the LM curve and solving for Y*.
D) not necessarily compute the corresponding level of GDP from either the IS or the LM curve.
E) none of the above.

Question 41

Suppose that the demand for money were to become less sensitive to changes in GDP. You would then expect

A) monetary policy to become less effective and fiscal policy to become more effective.
B) monetary policy to become more effective and fiscal policy to become less effective.
C) no change in the relative effectiveness of either fiscal or monetary policy.
D) both monetary policy and fiscal policy to become more effective.
E) both monetary policy and fiscal policy to become less effective.

Question 42

If investment were shown to be insensitive to changes in the interest rate, then we would expect to see

A) a steep IS curve.
B) a flat IS curve.
C) a steep LM curve.
D) a flat LM curve.
E) a vertical LM curve.

Question 43

The price adjustments of a dynamic model are founded on the intuition that

A) upward pressure should be exerted on prices if actual GDP exceeds potential GDP.
B) downward pressure should be exerted on prices if actual GDP falls short of potential GDP.
C) downward pressure should be exerted on prices if unemployment in excess of the natural rate puts downward pressure on wages.
D) upward pressure should be exerted on prices if employment above potential employment portends upward pressure on wages.
E) all of the above.

Question 44

In the short run, output is determined almost exclusively by

A) the level of the capital stock.
B) the level of current investment.
C) the level of government spending.
D) recent changes in technology.
E) the sum total of aggregate demand.

Question 45

Suppose net exports were to become less sensitive to changes in the interest rate. You would then draw

A) flatter IS and aggregate demand curves.
B) flatter LM and aggregate demand curves.
C) a flatter IS curve and a correspondingly steeper aggregate demand curve.
D) steeper IS and aggregate demand curves.
E) a steeper IS curve and a correspondingly flatter aggregate demand curve.

Question 46

The slope of an aggregate demand curve is determined by

A) the sensitivity of the demand for money to changes in the interest rate.
B) the sensitivity of investment to changes in the interest rate.
C) the sensitivity of the demand for money to changes in GDP.
D) the marginal propensity to consume.
E) all of the above.

Question 47

Suppose that the demand for money were to become less sensitive to changes in GDP. You would then draw

A) flatter LM curves and steeper aggregate demand curves.
B) steeper LM curves and flatter aggregate demand curves.
C) flatter aggregate demand and LM curves.
D) flatter LM curves but no corresponding change in the slope of the aggregate demand curve.
E) LM and aggregate demand curves with the same slopes as before.

Question 48

One difference between the short run and the long run in macroeconomics is that

A) aggregate supply defines GDP in the short run, whereas aggregate demand, given a price, defines GDP in the long run.
B) prices that can be assumed exogenous in the long run tend to vary wildly in the short run.
C) aggregate demand defines GDP given an exogenous price level in the short run, whereas aggregate supply defines GDP in the long run with flexible prices.
D) people can form expectations about what will happen over the long run but are completely in the dark about the random walk uncertainties of the short run.
E) none of the above.

Question 49

Given IS and LM curves of the usual slope, an upward price shock from abroad can be expected to cause

A) nominal interest rates to rise and real interest rates to fall.
B) both nominal and real interest rates to fall.
C) nominal interest rates to fall and real interest rates to rise.
D) both nominal and real interest rates to climb.
E) an unknown affect, because we cannot tell from the information given.

Question 50

Actual GDP will fall short of potential GDP in the short run if

A) the aggregate supply schedule falls short of actual GDP at the full employment level.
B) existing prices correspond to a level of aggregate demand in excess of potential GDP.
C) existing prices correspond to a level of aggregate demand below potential GDP.
D) the existing capital stock produces aggregate demand that is smaller than the corresponding aggregate supply.
E) none of the above.

Question 51

Suppose investment were to become more sensitive to changes in the interest rate. You would then draw

A) flatter IS and AD curves.
B) flatter LM and aggregate demand curves.
C) a flatter IS curve and a correspondingly steeper aggregate demand curve.
D) steeper IS and AD curves.
E) a steeper IS curve and a correspondingly flatter aggregate demand curve.

Question 52

Suppose that net exports were to become more sensitive to changes in the interest rate. You would expect to see

A) both fiscal and monetary policy become more effective.
B) both fiscal and monetary policy become less effective.
C) monetary policy become more effective and fiscal policy become less effective.
D) fiscal policy become more effective and monetary policy become less effective.
E) fiscal policy become more effective without any change in the effectiveness of monetary policy.

Question 53

Suppose that a reduction in the tax rate were expected to increase the after- tax income of all citizens by a total of $10 billion. Suppose further that this money were to be transferred in one payment in April. We should expect

A) GDP to climb by less than $10 billion because the stimulus would certainly increase interest rates enough to dampen investment.
B) GDP to climb by more than $10 billion as long as interest rates did not climb too severely.
C) GDP to climb by exactly $10 billion if interest rates were to hold steady.
D) GDP to be unaffected, since most people would put such a lump sum windfall tax savings in the bank "for a rainy day."
E) none of the above.

Question 54

An aggregate demand curve slopes downward against prices because

A) the quantity demanded almost always falls as the price climbs.
B) increases in the price level effectively reduce the real money supply and thereby increase interest rates, lower investment, and cause GDP to contract.
C) increases in the price level automatically increase real interest rates and therefore require a contraction in GDP to maintain equality of supply and demand in the money market.
D) reductions in the price level increase real GDP by the simple algebra of dividing nominal GDP by a price level.
E) none of the above.

Question 55

Suppose that the demand for money were to become less sensitive to changes in the interest rate. You would then draw

A) a flatter LM curve and a more vertical aggregate demand curve.
B) flatter LM and aggregate demand curves.
C) a flatter aggregate demand curve and a more vertical LM curve.
D) a flatter LM curve but no corresponding change in the slope of the aggregate demand curve.
E) a steeper LM curve but no corresponding change in the slope of the aggregate demand curve.