Question 1

The LM curve is steeper the _____ the interest sensitivity of money demand and the _____ the effect of income on money demand.
A)greater; greater
B)greater; smaller
C)smaller; smaller
D)smaller; greater

Accepted Answer

The LM curve is steeper the smaller the interest sensitivity of money demand (meaning people's demand for money is less responsive to changes in interest rates) and the greater the effect of income on money demand (meaning as income increases, the demand for money increases significantly). This combination makes the LM curve steeper because a small increase in income leads to a large increase in the demand for money, which requires a significant increase in interest rates to restore equilibrium in the money market.

Question 2

The debt-deflation hypothesis explains the fall in income as a consequence of unexpected deflation transferring wealth _____, and that creditors have a _____ propensity to consume than debtors.
A)from debtors to creditors; smaller
B)from debtors to creditors; larger
C)from creditors to debtors; smaller
D)from creditors to debtors; larger

Accepted Answer

The debt-deflation hypothesis suggests that unexpected deflation increases the real value of debt, transferring wealth from debtors to creditors. Creditors typically have a smaller propensity to consume than debtors, leading to a decrease in overall demand and income.

Question 3

In the IS-LM model, starting with zero expected inflation, if expected inflation becomes negative, then the:
A)IS curve shifts leftward.
B)IS curve shifts rightward.
C)LM curve shifts leftward.
D)LM curve shifts rightward.

Accepted Answer

When expected inflation becomes negative, the real interest rate increases, which leads to a decrease in investment and consumption. This shifts the IS curve leftward.

Question 4

The Pigou effect suggests that falling prices will increase income because real balances influence _____ and will shift the _____ curve.
A)money demand; LM
B)the money supply; LM
C)consumer spending; IS
D)government spending; IS

Accepted Answer

The Pigou effect suggests that falling prices increase the real value of money, which boosts consumer spending. This, in turn, shifts the IS curve, which represents the relationship between interest rates and levels of income that are in equilibrium in the goods market.

Question 5

If the demand function for money is M / P = 0.2Y - 200r, and if M / P increases by 100, then the LM curve for any given interest rate shifts to the:
A)left by 100.
B)left by 500.
C)right by 100.
D)right by 500.

Accepted Answer

The LM curve shifts to the right by 500 because an increase in real money balances (M/P) by 100 increases the equilibrium income level by 500, given the coefficient of income (0.2) in the money demand function.

Question 6

If the demand function for money is M / P = 0.5Y - 100r, then the slope of the LM curve is:
A)0.001.
B)0.005.
C)0.01.
D)0.05.

Accepted Answer

The answer of If the demand function for money is...

Question 7

Analysis of the short run and long run indicates that the _____ assumptions are most appropriate in _____.
A)classical; both the short run and the long run
B)Keynesian; both the short run and the long run
C)classical; the short run, whereas the Keynesian assumptions are most appropriate in the long run
D)Keynesian; the short run, whereas the classical assumptions are most appropriate in the long run

Accepted Answer

Keynesian assumptions are typically applied to the short run where prices and wages are sticky, while classical assumptions are more applicable in the long run where prices and wages are flexible.

Question 8

The slope of the IS curve depends on:
A)the interest sensitivity of investment and the amount of government spending.
B)the interest sensitivity of investment and the marginal propensity to consume.
C)the interest sensitivity of investment and the tax rates.
D)tax rates and government spending.

Accepted Answer

The slope of the IS curve depends on the interest sensitivity of investment and the marginal propensity to consume because these factors determine how changes in interest rates affect investment and consumption, which in turn influence aggregate demand and output.

Question 9

Other things equal, an expected deflation can change demand by:
A)lowering the demand for money, thus shifting the LM curve.
B)increasing the demand for money, thus shifting the LM curve.
C)raising the real interest rate for any given nominal interest rate, thus reducing desired investment.
D)lowering the real interest rate for any given nominal interest rate, thus increasing desired investment.

Accepted Answer

An expected deflation raises the real interest rate for any given nominal interest rate, making investment less attractive. Therefore, the desired investment decreases, causing a leftward shift in the aggregate demand curve.

Question 10

If real money balances enter the IS-LM model both through the theory of liquidity preference and the Pigou effect, then a fall in the price level will shift:
A)only the LM curve.
B)only the IS curve.
C)both the LM and the IS curves.
D)neither the LM nor the IS curve.

Accepted Answer

Both the theory of liquidity preference and the Pigou effect suggest that a fall in the price level will increase real money balances, leading to a shift in the LM curve. Additionally, the Pigou effect suggests that the increase in real money balances will also stimulate spending and shift the IS curve to the right. Therefore, both the LM and the IS curves will shift in response to a fall in the price level.

Question 11

A liquidity trap occurs when:
A)banks have too much currency and close their doors to new customers.
B)the central bank mistakenly prints too much money, generating hyperinflation.
C)interest rates fall so low that monetary policy is no longer effective.
D)dams and locks are built to prevent flooding.

Accepted Answer

A liquidity trap occurs when interest rates fall so low that monetary policy is no longer effective. This means that increasing the money supply does not lead to increased spending and investment in the economy because interest rates are already so low that people and businesses are not incentivized to borrow more. This can lead to a stagnation in economic growth and high unemployment.

Question 12

If money demand does not depend on the interest rate, then the LM curve is _____, and _____ policy has no effect on output.
A)horizontal; fiscal
B)vertical; fiscal
C)horizontal; monetary
D)vertical; monetary

Accepted Answer

The answer of If money demand does not depend on...

Question 13

The debt-deflation theory of the Great Depression suggests that an _____ deflation redistributes wealth in such a way as to _____ spending on goods and services.
A)unexpected; reduce
B)unexpected; increase
C)expected; reduce
D)expected; increase

Accepted Answer

The debt-deflation theory of the Great Depression suggests that an unexpected deflation redistributes wealth in such a way as to reduce spending on goods and services. As asset prices fall, borrowers face an increased burden of debt, which reduces their ability and willingness to borrow and spend, leading to a contraction in aggregate demand.

Question 14

Other things equal, a given change in government spending has a larger effect on demand the:
A)flatter the LM curve.
B)steeper the LM curve.
C)smaller the interest sensitivity of money demand.
D)larger the income sensitivity of money demand.

Accepted Answer

The answer of Other things equal, a given change in...

Question 15

The money hypothesis suggests that the Great Depression was caused by a:
A)leftward shift in the IS curve.
B)rightward shift in the IS curve.
C)leftward shift in the LM curve.
D)rightward shift in the LM curve.

Accepted Answer

The money hypothesis suggests that the Great Depression was caused by a leftward shift in the LM curve. This was brought about by the Federal Reserve's contractionary monetary policy, which reduced the money supply and raised interest rates, leading to a fall in investment and consumption spending.

Question 16

One explanation for the impact of expected price changes on the level of output is that an increase in expected deflation _____ the nominal interest rate and _____ the real interest rate, so that investment spending declines.
A)lowers; raises
B)raises; lowers
C)raises; raises
D)lowers; lowers

Accepted Answer

An increase in expected deflation lowers the nominal interest rate because central banks may lower rates to stimulate the economy. However, it raises the real interest rate because the real interest rate is adjusted for inflation, and deflation increases the value of money over time, making borrowing more expensive in real terms. This discourages investment spending.

Question 17

During the financial crisis of 2008-2009, many financial institutions in Canada reduced the amount of loans, even to creditworthy customers, which could be represented in the IS-LM model as a(n):
A)expansionary shift in the IS curve.
B)contractionary shift in the IS curve.
C)expansionary shift in the LM curve.
D)contractionary shift in the LM curve.

Accepted Answer

A reduction in loans, even to creditworthy customers, indicates a decrease in investment and spending, leading to a contractionary shift in the IS curve.

Question 18

Investment depends on the _____ interest rate, and money demand depends on the _____ interest rate.
A)real; real
B)nominal; nominal
C)real; nominal
D)nominal; real

Accepted Answer

Investment depends on the real interest rate because investors are concerned with how much of a return they will receive adjusted for inflation. Money demand, on the other hand, depends on the nominal interest rate because individuals are concerned with how much interest they will receive on their savings without taking inflation into account.

Question 19

A given increase in taxes shifts the IS curve more to the left the:
A)larger the marginal propensity to consume.
B)smaller the marginal propensity to consume.
C)larger the government spending.
D)smaller the government spending.

Accepted Answer

A larger marginal propensity to consume means that consumers are more likely to spend additional income, so a tax increase (which reduces disposable income) would lead to a larger decrease in consumption and a more significant shift of the IS curve to the left.

Question 20

Other things equal, a given change in government spending has a larger effect on demand the:
A)flatter the IS curve.
B)steeper the IS curve.
C)larger the interest sensitivity of expenditure demand.
D)smaller the interest sensitivity of money demand.

Accepted Answer

The steeper the IS curve, the more responsive expenditures are to changes in interest rates. This means that a given change in government spending will have a larger effect on demand when the IS curve is steeper.

Quiz 12: Aggregate Demand Ii: Applying the Islm Model

The LM curve is steeper the _ the interest sensitivity of money demand and the _ the effect of income on money demand.

The debt-deflation hypothesis explains the fall in income as a consequence of unexpected deflation transferring wealth _, and that creditors have a _ propensity to consume than debtors.

In the IS-LM model, starting with zero expected inflation, if expected inflation becomes negative, then the:

The Pigou effect suggests that falling prices will increase income because real balances influence _ and will shift the _ curve.

If the demand function for money is M / P = 0.2Y - 200r, and if M / P increases by 100, then the LM curve for any given interest rate shifts to the:

If the demand function for money is M / P = 0.5Y - 100r, then the slope of the LM curve is:

Analysis of the short run and long run indicates that the _ assumptions are most appropriate in _.

The slope of the IS curve depends on:

Other things equal, an expected deflation can change demand by:

If real money balances enter the IS-LM model both through the theory of liquidity preference and the Pigou effect, then a fall in the price level will shift:

A liquidity trap occurs when:

If money demand does not depend on the interest rate, then the LM curve is _, and _ policy has no effect on output.

The debt-deflation theory of the Great Depression suggests that an _ deflation redistributes wealth in such a way as to _ spending on goods and services.

Other things equal, a given change in government spending has a larger effect on demand the:

The money hypothesis suggests that the Great Depression was caused by a:

One explanation for the impact of expected price changes on the level of output is that an increase in expected deflation _ the nominal interest rate and _ the real interest rate, so that investment spending declines.

During the financial crisis of 2008-2009, many financial institutions in Canada reduced the amount of loans, even to creditworthy customers, which could be represented in the IS-LM model as a(n) :

Investment depends on the _ interest rate, and money demand depends on the _ interest rate.

A given increase in taxes shifts the IS curve more to the left the:

Other things equal, a given change in government spending has a larger effect on demand the: