#12 Aggregate Demand I: Building The IS-LM Model

Question 1

Long run

Answer 1

Prices are flexible

Output determined by factors of production and technology

Unemployment equals its natural rate

Question 2

Short run

Answer 2

Prices fixed

Output determined by aggregate demand

Unemployment negatively related to output

Question 3

Keynesian Cross

Answer 3

Simple closed-economy model in which income is determined by expenditure

Question 4

Planned Expenditure

Answer 4

PE = C + I + G

Question 5

Actual Expenditure

Answer 5

Y = real GDP = actual expenditure

Question 6

Difference between actual expenditure and planned expenditure

Answer 6

Unplanned inventory investment

Question 7

Elements of Keynesian cross

Answer 7

Consumption C = C(Y-T)

Actual Expenditure = Planned Expenditure
Y = PE

Question 8

Change in Y (income) equal to

G

Answer 8

Delta Y / Delta G = 1 / 1 - MPC

Question 9

Increase in government purchases…

Answer 9

Increases PE by Delta G

Question 10

Change in Y (income) is equal to…

T

Answer 10

Delta Y / Delta T = -MPC / 1 - MPC

Question 11

Decrease in taxes…

Answer 11

Increases PE by MPC x Delta T

Question 12

Tax multiplier…

Answer 12

Is negative
Tax increase reduces C —> reduces income

Is greater than 1

Is smaller than gov.spending multiplier

Question 13

IS Curve

Answer 13

Graph of all combinations of r and Y that result in goods market equilibrium

Question 14

IS Curve equation

Answer 14

Y = C(Y-T) + I(r) + G

Question 15

IS Curve

Real interest rate decreased…

Answer 15

Planned investment increased

Income increased

Question 16

Why is IS negativity sloped

Answer 16

Fall in the interest rate motivates firms to increase investment spending which drives up total planned spending (PE)

Question 17

Theory of liquidity preference

Answer 17

Simple theory in which the interest rate is determined by money supply and money demand

Question 18

LM Curve

Answer 18

Graph of all combinations of r and Y that equate the supply and demand for real money balances

Question 19

LM Curve equation

Answer 19

M / P = L(r, Y)

Question 20

LM Curve

Income increase

Answer 20

Money demand to right

Interest rate increases

Question 21

LM Curve

Reducing money

Answer 21

Interest rates Increasing

LM Curve shifting up