2023-2024 MCQ

Question 1

Which of the following is not true for the IS/LM model?
a. Fixed price, short-run model
b. Interdependency between the goods and money markets
c. Interest rates are a function of investment
d. Keynesian demand-side model

Answer 1

c. Interest rates are a function of investment

(because interest rates are determined by the equilibrium conditions in the money market.)

lil explanation for IS/LM:

The IS/LM model describes the relationship between the goods market (IS curve) and the money market (LM curve) in an economy.

• The IS curve represents the equilibrium in the goods market
• interest rate influences investment and hence, the level of output (or income).
• interest rates decrease, investment increases, leading to higher output.
• The LM curve represents the equilibrium in the money market
• interest rate adjusts to balance money supply and money demand
• interest rates are determined by the supply and demand for money, not directly by investment.

Question 2

Which of the following is true for the IS/LM model?
a. Fixed price, short-run model
b. Interdependency between the goods and money markets
c. Interest rates are a function of investment
d. Keynesian demand-side model

Answer 2

a. Fixed price, short-run model: The IS/LM model is typically set in the short run with fixed prices, meaning it doesn’t account for changes in the price level.

b. Interdependency between the goods and money markets: The model illustrates the interaction between the goods market (IS curve) and the money market (LM curve), showing how they are interdependent.

d. Keynesian demand-side model: The IS/LM framework is a Keynesian model, emphasizing demand-side factors in determining economic output and interest rates.

“which one is true,” the most encompassing and defining characteristics of the IS/LM model would be:

b. Interdependency between the goods and money markets

This is the core feature of the IS/LM model, showing the relationship and equilibrium between the two markets. The other correct options describe specific aspects or assumptions of the model, but this choice captures the essence of what the IS/LM model is designed to demonstrate.

Question 3

Gross Domestic Product (GDP)

a. is a stock concept, measures recorded economic activity, is a measurement at a point in time
b. is a stock concept, measures unrecorded economic activity, is a measurement at a point in time
c. is a flow concept, measures recorded economic activity, is a measurement over time
d. is a flow concept, measures unrecorded economic activity, is a measurement over time

Answer 3

c. is a flow concept, measures recorded economic activity, is a measurement over time

explanation:

Flow Concept: GDP is a flow concept because it measures the value of economic activity (goods and services produced) over a specific period, such as a quarter or a year, rather than at a single point in time.

Measures Recorded Economic Activity: GDP includes all officially recorded economic activities within a country, encompassing the total value of goods and services produced. It does not account for unrecorded or informal economic activities.

Measurement Over Time: GDP is calculated for a specific time period, providing a snapshot of the economic performance of a country over that interval, rather than at a particular moment.

Question 4

In the different components of Aggregate Expenditure, Transfer payments are accounted for in:

a. Exports (X)
b. Investment (I)
c. Consumption (C)
d. Government Spending (G)

Answer 4

d. Government Spending (G)

Explanation:
Transfer payments are included in the component of Government Spending (G) in the calculation of aggregate expenditure. However, it’s important to note that while transfer payments are part of government outlays, they do not directly contribute to GDP calculations under the expenditure approach. This is because transfer payments, such as social security benefits, unemployment insurance, and subsidies, do not correspond to the purchase of goods and services. Instead, they are redistributions of income, which can indirectly affect other components of aggregate expenditure, such as consumption (C), when recipients spend the money.

Question 5

In the IS/LM/BP model it is not possible to attain which of the following, simultaneously?

a Effective monetary policy and a flexible exchange rate
b A fixed exchange rate, perfect capital mobility and an independent monetary policy
c A fixed exchange rate and effective fiscal policy
d Internal and external balances

Answer 5

b A fixed exchange rate, perfect capital mobility and an independent monetary policy

explanation:This outcome aligns with the “impossible trinity” or the “trilemma” in international economics, which posits that it is impossible for a country to achieve the following three objectives simultaneously:A fixed exchange rate: This requires the central bank to intervene in the foreign exchange market to maintain a stable currency value.Perfect capital mobility: This allows capital to flow freely across borders without restrictions.An independent monetary policy: This means the central bank can set interest rates according to domestic economic conditions without having to stabilize the exchange rate.When a country chooses two of these objectives, it must forgo the third. For example, with a fixed exchange rate and perfect capital mobility, the country cannot have an independent monetary policy because the central bank’s actions would need to focus on maintaining the exchange rate, limiting its ability to influence domestic economic conditions through monetary policy.Thus, option b correctly describes a situation that cannot be achieved simultaneously according to the IS/LM/BP model and the concept of the trilemma.

Question 6

Which pair below are examples of automatic stabilisers?
a interest rates and exchange rates
b saving and investment
c taxes and welfare payments
d prices and output

Answer 6

c taxes and welfare payments

Automatic stabilizers are economic policies and programs that automatically adjust with the economic cycle without additional government intervention. They help stabilize the economy by dampening the fluctuations in disposable income and thus consumption, smoothing the business cycle.

Taxes: As incomes rise during an economic expansion, people and businesses pay more in taxes, which reduces the amount of disposable income and helps cool the economy. Conversely, during a downturn, lower incomes result in lower tax payments, leaving more disposable income in the hands of consumers and businesses.
Welfare Payments: These include unemployment benefits and other social safety net programs. During a recession, more people qualify for unemployment benefits, providing them with income support and thereby maintaining consumption levels. Conversely, as the economy recovers and employment rises, fewer people need these benefits, naturally reducing government expenditure.
These mechanisms work automatically in response to changes in the economic environment, hence the term “automatic stabilizers.”

Question 7

The IS curve is a depiction of the goods market in equilibrium. It is also true that
a points left and below a given IS reflect excess supply of goods and services
b the IS curve slopes negatively because of the inverse relationship between interest rates and savings
c autonomous spending changes along any given IS curve
d the larger the sensitivity of investment to change in the interest rate, the flatter the IS curve

Answer 7

d the larger the sensitivity of investment to change in the interest rate, the flatter the IS curve

The IS curve represents the relationship between the interest rate and the level of output (or income) where the goods market is in equilibrium. Here’s why option d is correct:

Sensitivity of Investment to Interest Rates: The IS curve slopes downward because, generally, lower interest rates lead to higher investment spending, which increases aggregate demand and output. If investment is highly sensitive to changes in interest rates (i.e., a small change in interest rates leads to a large change in investment), then a given change in interest rates will result in a large change in output. This makes the IS curve flatter, indicating that small changes in interest rates can lead to significant changes in equilibrium output.
The other options are incorrect because:

a. Points left and below a given IS reflect excess supply of goods and services: This statement is inaccurate; the correct interpretation is that points to the right and above the IS curve indicate excess demand (shortage), while points to the left and below indicate excess supply (surplus).
b. The IS curve slopes negatively because of the inverse relationship between interest rates and savings: The IS curve slopes downward due to the inverse relationship between interest rates and investment, not savings. Higher interest rates generally discourage investment spending, leading to lower aggregate demand and output.
c. Autonomous spending changes along any given IS curve: Autonomous spending shifts the IS curve, rather than causing movement along it. Changes in autonomous spending, such as a rise in government expenditure or an increase in autonomous consumption, shift the entire IS curve to the right.

Question 8

In the AD/AS model, the aggregate demand curve is negatively sloped because of
a the interest rate effect, the Pigou effect, and the real balance effect
b the real balance effect, the interest rate effect and the wealth effect
c the Pigou effect, the real balance effect and the wealth effect
d the real balance effect, the interest rate effect and the international trade effect

Answer 8

d the real balance effect, the interest rate effect and the international trade effect

The aggregate demand (AD) curve is negatively sloped due to several effects:

The Real Balance Effect: When the price level falls, the real value of money holdings increases, making consumers feel wealthier and thus increasing their consumption. This leads to higher aggregate demand.
The Interest Rate Effect: A lower price level reduces the demand for money, leading to lower interest rates. Lower interest rates encourage more investment and consumption, increasing aggregate demand.
The International Trade Effect: When the domestic price level falls, domestic goods become cheaper relative to foreign goods. This increases exports and reduces imports, thus boosting aggregate demand.
Each of these effects explains why the AD curve slopes downward.

Question 9

In the simple Keynesian model of income determination, investment is
a a stock concept and is volatile
b a function of income and fluctuates with interest rates c the buying and selling of stocks and shares
d additions to the capital stock, and volatile

Answer 9

d additions to the capital stock, and volatile

Additions to the Capital Stock: In the Keynesian model, investment refers to spending on new capital goods and additions to the existing capital stock. This includes expenditures on machinery, buildings, and equipment.
Volatile: Investment is typically considered to be volatile because it is influenced by a variety of factors, including business expectations, interest rates, and overall economic conditions. It can fluctuate significantly over time due to changes in these factors.
Here’s why the other options are less accurate:

a. A stock concept and is volatile: Investment is a flow concept, not a stock concept. It represents expenditure on new capital over a period of time, rather than a quantity at a specific point in time.
b. A function of income and fluctuates with interest rates: In the simple Keynesian model, investment is not directly a function of income but rather is influenced by interest rates and business expectations.
c. The buying and selling of stocks and shares: This describes financial investment rather than physical or real investment, which is the focus in the Keynesian model.

Question 10

Using the IS/LM model, a monetary policy contraction
a is more effective, the larger the sensitivity of money demand to changes in the interest rate
b is more effective, the steeper is the IS curve
c shifts the LM curve to the right, reducing interest rates and increasing national output
d shifts the LM curve to the left, raising interest rates and reducing national output

Answer 10

d shifts the LM curve to the left, raising interest rates and reducing national output

Monetary Policy Contraction: This involves reducing the money supply, which shifts the LM curve to the left. The LM curve shows the relationship between interest rates and national income (output) for a given money supply.

Effect on Interest Rates: A contraction in monetary policy decreases the money supply, which leads to higher interest rates as there is less money available for lending.

Effect on National Output: Higher interest rates typically reduce investment and consumption, leading to a decrease in national output.
Thus, a contractionary monetary policy is characterized by a leftward shift of the LM curve, resulting in higher interest rates and lower national output.

Question 11

Assume we combine contractionary fiscal policy with expansionary monetary policy. The result is of this policy mix is
a lower interest rates and an indeterminate level of output
b higher interest rates and lower output
c lower interest rates and higher output
d higher interest rates and an indeterminate level of output

Answer 11

a lower interest rates and an indeterminate level of output

Contractionary Fiscal Policy: This involves reducing government spending or increasing taxes, which shifts the IS curve to the left. This generally leads to higher interest rates and lower output in the IS/LM framework.
Expansionary Monetary Policy: This involves increasing the money supply, which shifts the LM curve to the right. This generally leads to lower interest rates and higher output.
When both policies are enacted simultaneously:

Interest Rates: The expansionary monetary policy will reduce interest rates, while contractionary fiscal policy will put upward pressure on interest rates. The net effect on interest rates will typically be lower, but it depends on the relative magnitude of the shifts in the IS and LM curves.
Output: The contractionary fiscal policy tends to reduce output by shifting the IS curve leftward, while expansionary monetary policy tends to increase output by shifting the LM curve rightward. The combined effect on output is indeterminate because it depends on the relative strengths of the fiscal and monetary policy actions.
Thus, the result of this policy mix generally leads to lower interest rates and an indeterminate level of output, depending on the relative impacts of the contractionary fiscal policy and expansionary monetary policy.

Question 12

The slope of the AS curve reflects
a the real balance effect, the interest rate effect and the wealth effect
b the goods, money and foreign exchange markets equilibrium
c short-run versus long-run, wage flexibility, Classical versus Keynesian d the stance of fiscal, monetary and exchange rate policies

Answer 12

c short-run versus long-run, wage flexibility, Classical versus Keynesian

Short-Run vs. Long-Run: The slope of the AS curve differs in the short run and the long run. In the short run, the AS curve is typically upward-sloping due to nominal rigidities like sticky wages and prices. In the long run, the AS curve is vertical at the natural level of output, reflecting the idea that output is determined by factors such as technology and resources, not the price level.
Wage Flexibility: In the short run, wages and prices may be sticky, leading to an upward-sloping AS curve. As wages and prices adjust over time, the AS curve becomes vertical in the long run.
Classical vs. Keynesian Views: Classical economics posits that the AS curve is vertical in the long run due to flexible wages and prices. Keynesian economics, on the other hand, often emphasizes the short-run upward slope of the AS curve due to price and wage stickiness.
Therefore, option c accurately captures the factors that influence the slope of the AS curve by distinguishing between short-run and long-run perspectives and incorporating the role of wage flexibility and different economic theories.

Question 13

At equilibrium in the simple Keynesian model of income determination, which of the following statements is true?
a The market clears and quantity demanded equals quantity supplied
b Investment is equal to saving, and actual GDP is equal to potential GDP
c Investment is equal to saving, and income is equal to aggregate expenditure
d Aggregate expenditure is equal to income and actual GDP is equal to potential GDP

Answer 13

c Investment is equal to saving, and income is equal to aggregate expenditure

explanation:Investment is equal to saving: In the Keynesian model, equilibrium in the goods market occurs when the total amount of planned spending (aggregate expenditure) equals the total output or income produced. At this point, total investment in the economy must be equal to total savings, as any unplanned change in inventories would otherwise indicate a disequilibrium.Income is equal to aggregate expenditure: In equilibrium, the total income (or output) in the economy equals the total aggregate expenditure. This reflects the condition where what is produced (income) is exactly what is spent on goods and services (aggregate expenditure).The other options are incorrect because:a. The market clears and quantity demanded equals quantity supplied: This statement is more applicable to individual markets rather than the aggregate economy. In the Keynesian model, equilibrium focuses on aggregate expenditure and income rather than clearing markets in a microeconomic sense.b. Investment is equal to saving, and actual GDP is equal to potential GDP: While investment equals saving is correct, the simple Keynesian model does not necessarily imply that actual GDP equals potential GDP. In the Keynesian framework, actual GDP can be below potential GDP, especially if there is underemployment.d. Aggregate expenditure is equal to income and actual GDP is equal to potential GDP: While aggregate expenditure equals income is true at equilibrium, the model does not inherently ensure that actual GDP equals potential GDP. It only ensures that aggregate expenditure equals actual output at equilibrium.

Question 14

Which statement on the multiplier is false?
a the higher the MPC, the lower the multiplier
b Leakages reduce the size of the multiplier
c Keynes argued that the multiplier was relatively stable in the short run
d The multiplier relates spending changes to income changes

Answer 14

a the higher the MPC, the lower the multiplier

explanation:Higher MPC and Multiplier: The Marginal Propensity to Consume (MPC) is directly related to the size of the multiplier. Specifically, the higher the MPC, the larger the multiplier. This is because a higher MPC means that consumers spend a larger portion of additional income, which leads to a greater overall impact on aggregate demand and output. The formula for the multiplier is 11%E2%88%92MPC1%E2%88%92MPC1%E2%80%8B , so as MPC increases, the denominator decreases, and the multiplier increases.Leakages: Leakages such as savings, taxes, and imports reduce the size of the multiplier. When money is leaked from the circular flow of income, it reduces the overall impact of an initial change in spending.Keynes and Stability: Keynes did argue that the multiplier was relatively stable in the short run, given that the marginal propensities to consume and to save do not change drastically.Multiplier and Spending Changes: The multiplier effect relates changes in spending to changes in income. An initial increase in spending leads to a chain reaction of increased income and further spending.So, the incorrect statement is a because it misrepresents the relationship between MPC and the multiplier.

Question 15

Keynes’ General Theory differed from the Classical Theory. The pre-Keynesian school was dominated by which of the following?

a Self-correcting markets, full employment and wage stickiness
b Say’s Law, effective demand, and self-adjusting markets
c Market-clearing prices, Say’s Law and wage flexibility
d Equilibrium processes, balanced budgets and discretionary demand management

Answer 15

c Market-clearing prices, Say’s Law and wage flexibility

Market-Clearing Prices: Classical economics posited that markets are self-correcting and that prices adjust to clear markets, ensuring that supply equals demand.
Say’s Law: Say’s Law states that “supply creates its own demand,” meaning that production of goods and services will generate an equivalent amount of demand. This implies that overproduction or underconsumption is not a concern, as any output produced will find a market.
Wage Flexibility: The Classical Theory assumed that wages and prices are flexible and adjust to ensure that labor and goods markets are always in equilibrium. This flexibility was thought to ensure full employment and efficient market outcomes.
Keynes’ General Theory challenged these views by emphasizing that markets do not always self-correct, that effective demand can be insufficient to maintain full employment, and that wage and price rigidities can lead to prolonged periods of unemployment.

Question 16

Which of the following statements on the AD/AS model is false?
a The twin issues of inflation and economic growth can be depicted on the vertical and horizontal axis, respectively
QUESTION 18
Which statement on the multiplier is false?
b Equilibrium is where aggregate demand is equal to aggregate supply
c The AS line is always upward sloping
d Prices and output are the endogenous variables

Answer 16

c The AS line is always upward sloping

explanation:a. The twin issues of inflation and economic growth can be depicted on the vertical and horizontal axis, respectively: This is true. In the AD/AS model, the vertical axis typically represents the price level (inflation), and the horizontal axis represents real GDP (economic growth).b. Equilibrium is where aggregate demand is equal to aggregate supply: This is true. Equilibrium in the AD/AS model occurs where the aggregate demand (AD) curve intersects the aggregate supply (AS) curve.c. The AS line is always upward sloping: This is false. In the AD/AS model, the Aggregate Supply (AS) curve can take different shapes depending on the time frame:In the short run, the AS curve is often upward sloping because prices and wages are sticky.In the long run, the AS curve is typically vertical at the potential output level, indicating that the economy is at full employment and changes in the price level do not affect output.d. Prices and output are the endogenous variables: This is true. In the AD/AS model, the price level and output (real GDP) are determined by the intersection of the AD and AS curves and are thus considered endogenous variables.So, c is the false statement about the AD/AS model.

Question 17

The policy implications of the Keynesian income determination model are as follows

a Public works programmes and pro-cyclical fiscal policy
b Discretionary demand management and yearly balanced budgets
c Counter-cyclical fiscal policy and balanced budgets over the cycle
d Yearly balanced budgets and fiscal rules

Answer 17

c Counter-cyclical fiscal policy and balanced budgets over the cycle

Counter-Cyclical Fiscal Policy: Keynesian economics advocates for counter-cyclical fiscal policies, which involve increasing government spending or cutting taxes during a recession (to boost aggregate demand) and reducing spending or increasing taxes during an economic boom (to cool down the economy). This approach aims to stabilize the economy and smooth out the business cycle.
Balanced Budgets Over the Cycle: While Keynesian theory doesn’t necessarily prescribe strict yearly balanced budgets, it does support the idea of maintaining balanced budgets over the economic cycle. This means that during periods of economic expansion, the government should aim to run surpluses or reduce deficits, while during recessions, it should be willing to run deficits to stimulate the economy. This approach avoids excessive debt accumulation while still using fiscal policy to counteract economic fluctuations.
The other options are less aligned with Keynesian principles:

a. Public works programmes and pro-cyclical fiscal policy: Keynesian theory supports public works programs as a tool for stimulating the economy, but it generally opposes pro-cyclical fiscal policy, which exacerbates economic fluctuations.
b. Discretionary demand management and yearly balanced budgets: While Keynesian economics supports discretionary demand management, it does not typically advocate for yearly balanced budgets. Instead, it supports balancing budgets over the economic cycle.
d. Yearly balanced budgets and fiscal rules: Keynesian theory does not typically emphasize strict yearly balanced budgets or rigid fiscal rules, focusing more on the counter-cyclical use of fiscal policy.

Question 18

Using the AD/AS model, a tax change shifts
a neither the AD curve or AS curve as it is a microeconomic policy change
b only the AD curve as it is a demand-side policy
c only the AS curve as it is a supply-side policy
d the AD curve or AS curve, depending on the economic school of thought

Answer 18

b only the AD curve as it is a demand-side policy

explanation:Tax Change and Aggregate Demand (AD) Curve: In the AD/AS model, a tax change primarily affects the AD curve. Lower taxes increase disposable income for consumers and/or increase after-tax profits for businesses, which typically boosts consumption and investment, thereby shifting the AD curve to the right. Conversely, higher taxes reduce disposable income and profits, shifting the AD curve to the left.Aggregate Supply (AS) Curve: Tax changes generally do not directly affect the AS curve, which is more influenced by factors like production costs, technology, and labor. However, over the long term, changes in taxes can indirectly affect the AS curve by influencing investment and productivity, but this is not the immediate or direct effect.Economic School of Thought: While different schools of thought may emphasize different aspects of fiscal policy, the direct and immediate impact of a tax change is on the AD curve.Thus, a tax change is classified as a demand-side policy and primarily shifts the AD curve.

Question 19

Which of the following statements in relation to monetary policy is false?
a Monetary policy in Ireland is set by the Central Bank of Ireland
b The objective of monetary policy by the European Central Bank is price stability
c The monetary transmission mechanism outlines how monetary policy changes affect output d Quantitative easing is a form of money creation

Answer 19

a Monetary policy in Ireland is set by the Central Bank of Ireland

explanation:a. Monetary policy in Ireland is set by the Central Bank of Ireland: This statement is false. Since Ireland is a member of the Eurozone, monetary policy is set by the European Central Bank (ECB), not by the Central Bank of Ireland alone. The ECB is responsible for setting interest rates and implementing monetary policy across the entire Eurozone, including Ireland.b. The objective of monetary policy by the European Central Bank is price stability: This is true. The primary objective of the ECB is to maintain price stability within the Eurozone, which typically means keeping inflation rates low and stable.c. The monetary transmission mechanism outlines how monetary policy changes affect output: This is true. The monetary transmission mechanism describes how changes in monetary policy (such as changes in interest rates or money supply) affect economic activity, including output and employment.d. Quantitative easing is a form of money creation: This is true. Quantitative easing (QE) involves the central bank purchasing government bonds or other financial assets to increase the money supply and lower interest rates, which is a form of money creation.

Question 20

In terms of the AD/AS model, the Covid-19 pandemic caused a
a impossible to say
b demand-side and a supply-side shock, with falls in aggregate demand and aggregate supply
c supply-side shock only, with a fall in aggregate supply
d demand-side shock only, with a fall in aggregate demand

Answer 20

b demand-side and a supply-side shock, with falls in aggregate demand and aggregate supply

The COVID-19 pandemic had both demand-side and supply-side effects:

Supply-Side Shock: The pandemic disrupted production and supply chains globally, leading to a reduction in aggregate supply. This was due to factory shutdowns, labor shortages, and interruptions in global supply chains.
Demand-Side Shock: The pandemic also caused a decrease in aggregate demand due to reduced consumer spending, lower business investment, and increased uncertainty. Lockdowns and social distancing measures led to a significant decline in consumer and business activity.
Both effects led to a simultaneous fall in aggregate demand and aggregate supply in the AD/AS model.

Question 21

Under a flexible exchange rate system, the three endogenous variables in the IS/LM/BP model are
a prices, output and unemployment
b output, interest rates and money supply
c output, interest rates and exchange rate
d income, output and expenditure

Answer 21

c output, interest rates and exchange rate

explanation:In the IS/LM/BP model with a flexible exchange rate, the key endogenous variables are:Output (or Income): The level of real GDP or national income.Interest Rates: The cost of borrowing money, which is determined by the equilibrium in the money market (LM curve).Exchange Rate: The price of the domestic currency in terms of foreign currencies, which adjusts to maintain equilibrium in the foreign exchange market (BP curve).These variables are endogenous because their values are determined within the model based on the interactions between the IS curve (goods market), the LM curve (money market), and the BP curve (balance of payments).

Question 22

The three motives for holding money in the liquidity preference theory

a are used in the derivation of the downward sloping IS curve
b are related positively to income and interest rates
c are related to the interest rate, real balances and international trade effects
d are speculative, transactionary and precautionary

Answer 22

d are speculative, transactionary and precautionary

explanation:Transactionary Motive: This refers to holding money to facilitate everyday transactions. People need a certain amount of money to conduct regular purchases and transactions.Precautionary Motive: This refers to holding money as a safeguard against unexpected expenses or emergencies. It represents a desire to have liquidity available for unforeseen circumstances.Speculative Motive: This involves holding money to take advantage of future investment opportunities or changes in interest rates. For instance, if people expect interest rates to rise, they might hold onto money rather than invest it, waiting for better investment opportunities.These motives are part of the liquidity preference theory introduced by Keynes, which explains why people choose to hold money rather than invest it, depending on their needs and expectations regarding future economic conditions.

Question 23

In the third market of the IS/LM/BP, which of the following is false?
a The balance of payments line is usually upward sloping as interest rates and output are positively related
b The balance of payments line is horizontal when capital is perfectly mobile
c The balance of payments line represents the foreign exchange market
d The balance of payments line represents the assets market in equilibrium

Answer 23

a The balance of payments line is usually upward sloping as interest rates and output are positively related

explanation:a. The balance of payments line is usually upward sloping as interest rates and output are positively related: This statement is false. In the IS/LM/BP model, the balance of payments (BP) line is typically horizontal in the case of perfect capital mobility, indicating that the capital account is very responsive to changes in interest rates. However, in a more general setting with less than perfect capital mobility, the BP line can be upward sloping or downward sloping depending on how interest rates and output interact with the capital flows and the trade balance. The relationship between interest rates and the BP line%E2%80%99s slope depends on the specific assumptions about capital mobility and other factors.b. The balance of payments line is horizontal when capital is perfectly mobile: This is true. With perfect capital mobility, the BP line is horizontal because any differences in domestic interest rates versus foreign rates are instantly offset by capital flows, keeping the balance of payments in equilibrium.c. The balance of payments line represents the foreign exchange market: This is true. The BP line in the IS/LM/BP model represents the balance of payments, which encompasses the foreign exchange market’s equilibrium.d. The balance of payments line represents the assets market in equilibrium: This is true. The BP line represents the condition where the total balance of payments (including the capital account and the current account) is in equilibrium, which reflects equilibrium in the assets market.Therefore, a is the false statement regarding the BP line in the IS/LM/BP model.

Question 24

In our four main macroeconomic models, which of the following statements is false?
a Output is an exogenous variable
b Our macro models are all short-run models
c The goods and services market is represented in all four models
d Output is a variable to be determined

Answer 24

a Output is an exogenous variable

explanation:a. Output is an exogenous variable: This is false. In macroeconomic models, output is typically an endogenous variable, meaning it is determined within the model based on the interactions between other variables (such as aggregate demand and aggregate supply in the AD/AS model, or investment and savings in the IS/LM model). The value of output is not set outside the model but is derived from the model’s equilibrium conditions.b. Our macro models are all short-run models: This is generally true. Many of the main macroeconomic models, like the IS/LM model, AD/AS model, and the IS/LM/BP model, focus on short-run analysis. They examine how policies and shocks affect the economy in the short run, though some models may incorporate longer-term elements.c. The goods and services market is represented in all four models: This is true. Each of the main macroeconomic models (IS/LM, AD/AS, IS/LM/BP, and others) incorporates the goods and services market in some form, examining how output and aggregate demand interact.d. Output is a variable to be determined: This is true. In macroeconomic models, output is a variable that is determined through the interactions of other variables and the equilibrium conditions of the model.Therefore, a is the false statement as it mischaracterizes output as an exogenous variable, when in fact it is endogenous.

Question 25

In the IS/LM/BP model, which of the following statements is true?
a Fiscal policy is effective when the exchange rate is flexible
b Under a flexible exchange rate, monetary policy is effective
c The IS/LM/BP is a Keynesian-type long-run, supply-constrained model
d Above the horizontal BP line reflects a position of a balance of payments deficit

Answer 25

b Under a flexible exchange rate, monetary policy is effective

explanation:b. Under a flexible exchange rate, monetary policy is effective: This is true. In the IS/LM/BP model with a flexible exchange rate, monetary policy is effective because changes in the money supply can influence interest rates, which in turn affect capital flows and the exchange rate. For example, an expansionary monetary policy will typically lower domestic interest rates, leading to a depreciation of the currency, which can boost net exports and aggregate demand.a. Fiscal policy is effective when the exchange rate is flexible: This is generally false. With a flexible exchange rate, fiscal policy (such as changes in government spending or taxation) is less effective because changes in fiscal policy can lead to changes in the exchange rate, which may offset the intended effects of fiscal policy.c. The IS/LM/BP is a Keynesian-type long-run, supply-constrained model: This is false. The IS/LM/BP model is typically used for short-run analysis and is not a supply-constrained model. It focuses on the interaction of output, interest rates, and the balance of payments in the short run.d. Above the horizontal BP line reflects a position of a balance of payments deficit: This is false. In the IS/LM/BP model with perfect capital mobility, the horizontal BP line indicates a position where the balance of payments is in equilibrium. Above the horizontal BP line would typically indicate a surplus, while below it would indicate a deficit.Therefore, the accurate statement is b, as it correctly reflects the effectiveness of monetary policy under a flexible exchange rate in the IS/LM/BP model.

Question 26

With respect to the circular flow model of national income, which of the following statements is false?

a A rise in government spending, a fall in imports and an increase in investment increases economic activity
b A rise in exports, a fall in savings and an increase in transfer payments increases economic activity
c A rise in savings, an increase in exports and a decrease in taxes increases economic activity
d An increase in investment, a fall in taxes and an increase in exports increases economic activity

Answer 26

c A rise in savings, an increase in exports and a decrease in taxes increases economic activity

explanation:a. A rise in government spending, a fall in imports, and an increase in investment increases economic activity: This is true. Increased government spending, reduced imports (which means more spending on domestic goods), and increased investment all contribute to higher aggregate demand and economic activity.b. A rise in exports, a fall in savings, and an increase in transfer payments increases economic activity: This is true. Increased exports raise aggregate demand from foreign buyers. A fall in savings means more consumption, and increased transfer payments (e.g., social benefits) boost household income and consumption, all of which can increase economic activity.c. A rise in savings, an increase in exports, and a decrease in taxes increases economic activity: This statement is false because while an increase in exports and a decrease in taxes would increase economic activity, a rise in savings would typically decrease immediate economic activity. Higher savings means less current consumption, which can reduce aggregate demand in the short run.d. An increase in investment, a fall in taxes, and an increase in exports increases economic activity: This is true. Increased investment stimulates economic growth, a fall in taxes can boost disposable income and consumption, and an increase in exports raises aggregate demand from abroad, all contributing to higher economic activity.So, c is false because rising savings usually decreases current economic activity by reducing consumption, which offsets the positive effects of increased exports and decreased taxes.

Question 27

In the context of the money market and the LM curve, which of the following is true?
a The LM is steep when the sensitivity of money demand to changes in income is large
b The slope of the LM is determined by the sensitivity of investment to changes in interest rates c Points left and above a given LM reflect excess demand for money
d A decrease in the money supply shifts the LM curve down to the right

Answer 27

a The LM is steep when the sensitivity of money demand to changes in income is large

a. The LM is steep when the sensitivity of money demand to changes in income is large: This is false. The steepness of the LM curve is related to the sensitivity of money demand to changes in interest rates, not income. When money demand is highly sensitive to changes in interest rates, the LM curve is steeper.
b. The slope of the LM is determined by the sensitivity of investment to changes in interest rates: This is false. The slope of the LM curve is determined by the sensitivity of money demand to changes in the interest rate and the income level, not directly by investment.
c. Points left and above a given LM reflect excess demand for money: This is true. Points left of a given LM curve represent lower levels of income or output. Points above a given LM curve represent higher interest rates. Together, this combination (left and above) indicates that at that level of income and interest rate, there is an excess demand for money because the quantity of money demanded exceeds the quantity supplied.
d. A decrease in the money supply shifts the LM curve down to the right: This is false. A decrease in the money supply shifts the LM curve up (or to the left), indicating that at each level of income, higher interest rates are required to maintain money market equilibrium.
So, the correct statement about the LM curve is c.