Question 1

An explanation for the slope of the LM curve is that as:
A) the interest rate increases, income becomes higher.
B) the interest rate increases, income becomes lower.
C) income rises, money demand rises, and a higher interest rate is required.
D) income rises, money demand rises, and a lower interest rate is required.

Accepted Answer

As income rises, people demand more money for transactions and savings purposes, causing an increase in the demand for money. To maintain equilibrium in the money market, the interest rate has to increase to encourage people to supply more money. Therefore, the slope of the LM curve is positive, indicating an increase in interest rate with an increase in income.

Question 2

The theory of liquidity preference implies that the quantity of real money balances demanded is:
A) negatively related to both the interest rate and income.
B) positively related to both the interest rate and income.
C) positively related to the interest rate and negatively related to income.
D) negatively related to the interest rate and positively related to income.

Accepted Answer

The theory of liquidity preference, proposed by John Maynard Keynes, suggests that people prefer to hold onto cash (or liquid assets) rather than invest in securities when interest rates are low. Therefore, the demand for real money balances is negatively related to the interest rate (since higher interest rates make holding money less attractive) and positively related to income (since higher income increases the demand for transactions, thus increasing the demand for money).

Question 3

In the liquidity preference model, what adjusts to move the money market to equilibrium following a change in the money supply?
A) planned spending
B) the interest rate
C) production
D) the price level

Accepted Answer

According to the liquidity preference model, the interest rate adjusts to move the money market to equilibrium following a change in the money supply. An increase in the money supply leads to a decrease in the interest rate, while a decrease in the money supply leads to an increase in the interest rate. This adjustment in the interest rate helps to match the quantity of money demanded with the quantity of money supplied, bringing the money market back to equilibrium. The other choices, such as planned spending, production, and price level, are not directly related to the liquidity preference model and do not play a role in the adjustment process.

Question 4

The theory of liquidity preference implies that, other things being equal, an increase in the real money supply will:
A) lower the interest rate.
B) raise the interest rate.
C) have no effect on the interest rate.
D) first lower and then raise the interest rate.

Accepted Answer

The theory of liquidity preference states that individuals hold money for transactions and speculative purposes. As the real money supply increases, there is a greater supply of money available for individuals to hold for transactions and speculative purposes, meaning that they do not need to borrow as much money. This leads to a decrease in the demand for loanable funds, which in turn lowers the interest rate.

Question 5

According to the theory of liquidity preference, holding the supply of real money balances constant, an increase in income will ______ the demand for real money balances and will ______ the interest rate.
A) increase; increase
B) increase; decrease
C) decrease; decrease
D) decrease; increase

Accepted Answer

According to the theory of liquidity preference, an increase in income increases the demand for real money balances because people want to hold more money for transactions. With the supply of real money balances constant, this increased demand leads to an increase in the interest rate as people are willing to pay more to hold money.

Question 6

With the real money supply held constant, the theory of liquidity preference implies that a higher income level will be consistent with:
A) no change in the interest rate.
B) a lower interest rate.
C) a higher interest rate.
D) first a lower and then a higher interest rate.

Accepted Answer

According to the theory of liquidity preference, as income level increases, the demand for money also increases. This creates upward pressure on interest rates because individuals and firms are willing to pay more for money to finance their increased economic activity. Therefore, a higher income level is consistent with a higher interest rate.

Question 7

If the interest rate is above the equilibrium value, the:
A) demand for real balances exceeds the supply.
B) supply of real balances exceeds the demand.
C) market for real balances clears.
D) demand for real balances increases.

Accepted Answer

If the interest rate is above the equilibrium value, it means that the price of holding money (the interest rate) is too high and therefore the demand for money is lower and the supply of money is higher. This causes a surplus of real balances (money), so the supply of real balances exceeds the demand.

Question 8

Use the following to answer questions : Exhibit: Market for Real Money Balances -(Exhibit: Market for Real Money Balances) Based on the graph, if the interest rate is r₃, then people will ______ bonds and the interest rate will ______. A) sell; rise B) sell; fall C) buy; rise D) buy; fall

Accepted Answer

If the interest rate is at r₃, it indicates that the demand for real money balances is less than the supply at this interest rate, leading people to sell bonds to adjust their portfolios, which increases the supply of bonds and puts upward pressure on interest rates, causing them to rise.

Question 9

According to the theory of liquidity preference, tightening the money supply will ______ nominal interest rates in the short run, and, according to the Fisher effect, tightening the money supply will ______ nominal interest rates in the long run.
A) increase; increase
B) increase; decrease
C) decrease; decrease
D) decrease; increase

Accepted Answer

According to the theory of liquidity preference, tightening the money supply (reducing the amount of money available) will increase nominal interest rates in the short run because less money means borrowers are willing to pay more for loans. According to the Fisher effect, in the long run, tightening the money supply can lead to lower inflation expectations, which in turn can decrease nominal interest rates because nominal interest rates are the sum of real interest rates and expected inflation.

Question 10

An LM curve shows combinations of:
A) taxes and government spending.
B) nominal money balances and price levels.
C) interest rates and income, which bring equilibrium in the market for real money balances.
D) interest rates and income, which bring equilibrium in the market for goods and services.

Accepted Answer

The LM curve represents the equilibrium in the market for real money balances, which is determined by the intersection of the demand for real money balances (related to income) and the supply of real money balances (related to interest rates). Therefore, the LM curve shows combinations of interest rates and income (not taxes and government spending or nominal money balances and price levels), which bring equilibrium in the market for real money balances (not goods and services).

Question 11

A decrease in the real money supply, other things being equal, will shift the LM curve:
A) downward and to the left.
B) upward and to the left.
C) downward and to the right.
D) upward and to the right.

Accepted Answer

A decrease in the real money supply, other things being equal, will increase the interest rate, which will cause the LM curve to shift upward and to the left.

Question 12

A decrease in the nominal money supply, other things being equal, will shift the LM curve:
A) upward and to the right.
B) downward and to the right.
C) downward and to the left.
D) upward and to the left.

Accepted Answer

A decrease in the nominal money supply, other things being equal, will lead to a higher interest rate for any given level of income, which is represented by a shift of the LM curve upward and to the left in the interest rate-income (or output) space.

Question 13

A decrease in the price level, holding nominal money supply constant, will shift the LM curve:
A) upward and to the right.
B) downward and to the right.
C) downward and to the left.
D) upward and to the left.

Accepted Answer

A decrease in the price level, while holding the nominal money supply constant, increases the real money supply. This makes more money available for investment and consumption at each interest rate, effectively lowering the interest rate for any given level of income. This is represented by a shift of the LM curve downward and to the right, indicating that a lower interest rate is now associated with any given level of income.

Question 14

Use the following to answer questions : Exhibit: Market for Real Money Balances -(Exhibit: Market for Real Money Balances) Based on the graph, if the interest rate is r₁, then people will ______ bonds and the interest rate will ______. A) sell; rise B) sell; fall C) buy; rise D) buy; fall

Accepted Answer

The answer of Use the following to answer questions :
Exhibit:...

Question 15

Reducing the money supply ______ nominal interest rates in the short run, and ______ nominal interest rates in the long run.
A) produces no change in; raises
B) raises; produces no change in
C) raises; lowers
D) lowers; raises

Accepted Answer

Reducing the money supply raises nominal interest rates in the short run because it makes it more expensive for banks to borrow money. This, in turn, leads to higher interest rates on loans and other forms of borrowing. In the long run, however, reducing the money supply can actually lower nominal interest rates. This is because a smaller money supply means that there is less money chasing the same amount of goods and services. This can lead to lower prices, which in turn can lead to lower interest rates.

Question 16

According to the theory of liquidity preference, if the demand for real money balances exceeds the supply of real money balances, individuals will:
A) sell interest-earning assets in order to obtain non-interest-bearing money.
B) purchase interest-earning assets in order to reduce holdings of non-interest-bearing money.
C) purchase fewer goods and services.
D) be content with their portfolios.

Accepted Answer

According to the theory of liquidity preference, when the demand for real money balances surpasses the supply, individuals will try to obtain non-interest-bearing money by selling their interest-earning assets. This will increase the supply of interest-earning assets and lower their prices while at the same time increasing the demand for money and raising its price.

Question 17

Use the following to answer questions : Exhibit: Market for Real Money Balances -(Exhibit: Market for Real Money Balances) Based on the graph, the equilibrium levels of interest rates and real money balances are: A) r₁ and M₁/P₁ B) r₂ and M₂/P₂ C) r₃ and M₂/P₂ D) r₃ and M₃/P₃

Accepted Answer

The equilibrium levels of interest rates and real money balances occur where the supply and demand curves intersect, which is at point E with r₂ and M₂/P₂.

Question 18

The LM curve, in the usual case:
A) is vertical.
B) is horizontal.
C) slopes down to the right.
D) slopes up to the right.

Accepted Answer

The LM curve, which represents the relationship between the liquidity preference and the money supply in an economy, typically slopes up to the right. This indicates that higher interest rates are associated with higher levels of income, as higher income levels lead to increased demand for money, which in turn leads to higher interest rates.

Question 19

According to the theory of liquidity preference, if the supply of real money balances exceeds the demand for real money balances, individuals will:
A) sell interest-earning assets in order to obtain non-interest-bearing money.
B) purchase interest-earning assets in order to reduce holdings of non-interest-bearing money.
C) purchase more goods and services.
D) be content with their portfolios.

Accepted Answer

According to the theory of liquidity preference, if the supply of real money balances exceeds the demand for real money balances, individuals will seek to reduce their holdings of non-interest-bearing money by purchasing interest-earning assets such as bonds, stocks, or certificates of deposit. This is because people prefer to hold assets that earn some kind of return rather than holding onto non-interest-bearing money that loses value over time due to inflation. Thus, purchasing interest-earning assets is the best option for individuals in this situation.

Question 20

When Paul Volcker tightened the money supply:
A) the inflation rate immediately fell.
B) nominal interest rates fell in the short run.
C) nominal interest rates fell in the long run.
D) real balances rose in the short run.

Accepted Answer

When Paul Volcker tightened the money supply, it initially led to higher nominal interest rates in the short run as the supply of money decreased. However, in the long run, as inflation expectations adjusted downward due to the tighter monetary policy, nominal interest rates fell. This is because the real interest rate is approximately the nominal interest rate minus the inflation rate. As inflation decreased over time, nominal rates also decreased to reflect the lower inflation environment.

Quiz 11: Aggregate Demand I: Building the Is-Lm Model

An explanation for the slope of the LM curve is that as:

The theory of liquidity preference implies that the quantity of real money balances demanded is:

In the liquidity preference model, what adjusts to move the money market to equilibrium following a change in the money supply?

The theory of liquidity preference implies that, other things being equal, an increase in the real money supply will:

According to the theory of liquidity preference, holding the supply of real money balances constant, an increase in income will the demand for real money balances and will the interest rate.

With the real money supply held constant, the theory of liquidity preference implies that a higher income level will be consistent with:

If the interest rate is above the equilibrium value, the:

Use the following to answer questions : Exhibit: Market for Real Money Balances -(Exhibit: Market for Real Money Balances) Based on the graph, if the interest rate is r₃, then people will bonds and the interest rate will .

According to the theory of liquidity preference, tightening the money supply will nominal interest rates in the short run, and, according to the Fisher effect, tightening the money supply will nominal interest rates in the long run.

An LM curve shows combinations of:

A decrease in the real money supply, other things being equal, will shift the LM curve:

A decrease in the nominal money supply, other things being equal, will shift the LM curve:

A decrease in the price level, holding nominal money supply constant, will shift the LM curve:

Use the following to answer questions : Exhibit: Market for Real Money Balances -(Exhibit: Market for Real Money Balances) Based on the graph, if the interest rate is r₁, then people will bonds and the interest rate will .

Reducing the money supply nominal interest rates in the short run, and nominal interest rates in the long run.

According to the theory of liquidity preference, if the demand for real money balances exceeds the supply of real money balances, individuals will:

Use the following to answer questions : Exhibit: Market for Real Money Balances -(Exhibit: Market for Real Money Balances) Based on the graph, the equilibrium levels of interest rates and real money balances are:

The LM curve, in the usual case:

According to the theory of liquidity preference, if the supply of real money balances exceeds the demand for real money balances, individuals will:

When Paul Volcker tightened the money supply: