Question 1

Which of the following best defines the IS curve?

Accepted Answer

The IS curve illustrates the combinations of interest rates (i) and output (Y) that maintain equilibrium in the goods market, where planned investment equals planned saving. It shows the relationship between the interest rate and output, holding everything else constant. Choices A, C, D, and E do not correctly define the IS curve.

Question 2

In the IS- LM model, an increase in the money supply will cause an increase in which of the following variables?

Accepted Answer

An increase in the money supply will shift the LM curve downward, leading to lower interest rates. Lower interest rates will increase investment (shift the investment function upward), consumption (shift the consumption function upward), and output (shift the IS curve upward). Therefore, all of the above choices are correct.

Question 3

Suppose there is a decrease in consumer confidence and the central bank controls the money supply. Which of the following represents the complete list of variables that must decrease in response to this consumer pessimism?

Accepted Answer

The answer of Suppose there is a decrease in consumer...

Question 4

We know with certainty that a tax cut must cause which of the following?

Accepted Answer

A tax cut increases disposable income, which leads to an increase in consumption and investment. This, in turn, leads to an increase in output.

Question 5

Suppose the current level of output and the interest rate are such that the economy is operating on neither the IS nor LM curve. Which of the following is true for this economy?

Accepted Answer

If the economy is not operating on either the IS or LM curve, it means that neither the goods market nor the money market is in equilibrium, which implies that production does not equal demand and the money supply does not equal money demand. In addition, the interest rate is such that the quantity supplied of bonds does not equal the quantity demanded for bonds, indicating that financial markets are also not in equilibrium.

Question 6

Based on our understanding of the IS- LM model that takes into account dynamics, we know that a decrease in government spending will cause:

Accepted Answer

A decrease in government spending will initially shift the IS curve to the left, leading to a lower equilibrium output (Y) and interest rate (i) as the economy adjusts to the new equilibrium. This adjustment is gradual due to the dynamics of consumption, investment, and other components of aggregate demand responding to the change in government spending.

Question 7

A reasonable dynamic assumption for the IS- LM model is that:

Accepted Answer

The answer of A reasonable dynamic assumption for the IS-...

Question 8

Suppose there is a simultaneous tax increase and open market purchase of bonds. Which of the following must occur as a result of this?

Accepted Answer

Both the open market purchase of bonds and the tax increase work to decrease aggregate demand. However, the open market purchase of bonds leads to an increase in the money supply and thus a decrease in interest rates. Therefore, the decrease in interest rates resulting from the open market purchase of bonds would offset the increase in interest rates resulting from the decrease in demand due to the tax increase. Overall, the interest rate would decrease, which is the opposite of what would happen in option E.

Question 9

Assume that investment does not depend on the interest rate. An increase in the money supply will cause which of the following for this economy?

Accepted Answer

If investment does not depend on the interest rate, an increase in the money supply, which typically lowers interest rates, would not affect investment levels, leading to no change in investment.

Question 10

The IS curve will not shift when which of the following occurs?

Accepted Answer

The IS curve represents the equilibrium level of output at different interest rates. A decrease in the interest rate will lead to an increase in investment and consumption, which will shift the aggregate demand curve to the right. However, it will not shift the IS curve since the interest rate is already included in the equation for the IS curve. The other options will shift the IS curve because they affect one or more components of aggregate demand, and therefore affect the equilibrium level of output at each interest rate.

Question 11

Based on our understanding of the IS- LM model that takes into account dynamics, we know that a decrease in the money supply will cause:

Accepted Answer

In the IS-LM model, a decrease in the money supply shifts the LM curve upward and to the left. This leads to a decrease in equilibrium output (Y) and an increase in equilibrium interest rates (i). However, these adjustments occur gradually over time, rather than immediately. Therefore, option C is the most accurate description of the effects of a decrease in the money supply.

Question 12

Which of the following statements is consistent with a given LM curve?

Accepted Answer

The LM curve represents the relationship between liquidity (money supply and demand) and output in the economy. An increase in output leads to an increase in money demand as more transactions require more money, which is consistent with the properties of the LM curve.

Question 13

A decrease in consumer confidence will likely have which of the following effects?

Accepted Answer

A decrease in consumer confidence will lead to a decrease in consumption and therefore a decrease in aggregate demand. This will result in a leftward shift in the IS curve, as less output is demanded at any given interest rate. It will not affect the LM curve, as it is determined by the money market and not by changes in consumer behavior.

Question 14

Assume that investment spending depends only on output and no longer depends on the interest rate. Given this information, an increase in government spending:

Accepted Answer

The answer of Assume that investment spending depends only on...

Question 15

Assume that investment does not depend on the interest rate. A decrease in government spending will cause which of the following for this economy?

Accepted Answer

The answer of Assume that investment does not depend on...

Question 16

Suppose fiscal policy makers implement a policy to increase the size of a budget deficit. Based on the IS- LM model, we know with certainty that the following will occur as a result of this fiscal policy action:

Accepted Answer

According to the IS-LM model, an increase in government spending would shift the IS curve to the right, leading to an increase in output. Therefore, the correct answer is B, output increases. The other options are not necessarily true, as the effect of fiscal policy on the price level and investment spending depends on various factors such as the initial position of the economy in the IS-LM model, the nature of the fiscal policy action, and the central bank's response.

Question 17

Assume that investment spending depends only on the interest rate and no longer depends on output. Given this information, a decrease in government spending:

Accepted Answer

A decrease in government spending reduces aggregate demand, leading to a decrease in output and interest rates. Since investment depends only on the interest rate, lower interest rates will cause investment to increase.

Question 18

Based on our understanding of the IS- LM model, we know with certainty that the policy mix in Australia in response to the global crisis would have resulted in:

Accepted Answer

The IS-LM model suggests that a policy mix of fiscal expansion (increased government spending or tax cuts) and monetary expansion (lower interest rates) would lead to an increase in output.

Question 19

A RBA sale of securities will most likely have which of the following effects?

Accepted Answer

A sale of securities by the Reserve Bank of Australia (RBA) reduces the money supply, leading to higher interest rates, which causes the LM curve to shift upward.

Question 20

Under the reasonable dynamic assumptions, a temporary monetary contraction should result in:

Accepted Answer

Under reasonable dynamic assumptions, a temporary monetary contraction would initially lead to an increase in interest rates due to the reduced supply of money. Over time, as the economy adjusts, the interest rate would fall back as the temporary effects of the contraction dissipate.

Quiz 5: Goods and Financial Markets: the Islm Model