Exam 2 (Ch. 5 - 6) Flashcards
According to Keynes, high unemployment in GB and USA was the result of a deficiency in:
aggregate demand.
What does Keynesian theory plan to use monetary and fiscal policy for?
To regulate aggregate demand.
In Keynesian theory, equilibrium level of output requires that:
output be equal to aggregate demand.
When output exceeds desired expenditures (Y>E) what happens to inventories and production?
Inventories rise unintentionally
Production slows down
Keynes believed that investment spending was (4)
- highly unstable
- heavily influenced by expectations
- heavily influenced by interest rates
- makes RGDP subject to “fits and starts”
The tax multiplier is smaller in absolute value relative to the government spending multiplier because…
taxes influence desired expenditures indirectly through consumption spending while government spending influences desired expenditures directly.
If government spending and taxes both rise by 50 units and the MPC is 0.75 then equilibrium income will..
Rise by 50 units (balanced budget multiplier–taxes and gov’t spending increase Yd 1:1)
An increase in taxes causes..
a decrease in desired expenditures and reduces equilibrium output
An increase in government spending causes..
an increase in desired expenditures and increases equilibrium output.
MPC = 0.9
Government wants to raise equilibrium output by 10,000.
How much should government spending change?
Increase by 1000 (delta G = 1000)
delta Y / delta G = 1/(1-MPC)
MPC = 0.75
Government wants to raise equilibrium output by 10,000.
How much should taxes change?
Decrease by 3000 (delta T = -3000)
delta Y / delta T = -MPC/(1-MPC)
If the savings function is:
S = -25 + 0.2 * Yd
What is the consumption function?
C = 25 + 0.8 * Yd
C = a + MPC * Yd S = -a + (1-MPC) * Yd
According to Keynes, the level of consumer expenditure is a stable function of:
disposable income.
What happens in the bond market when individuals have an excess supply of money?
People will purchase bonds which will lead to an excess demand for bonds.
What happens in the bond market when individuals have an excess demand for money?
People will sell bonds causing prices to fall and interest rates to rise.
In the money market, an increase in income causes
an increase in the demand for money which leads to higher interest rates and a movement along a given LM curve.
An increase in the money supply
puts downward pressure on interest rates in the money market and causes the LM curve to shift to the right.
A rise in the level of the money supply generates
4 things
- an excess supply of money
- a larger demand for bonds
- a higher market price for bonds
- a lower market interest rate
If investment spending increases what happens to the IS curve?
The IS curve will shift to the right
Expansionary fiscal policy (increases in government spending or decreases in taxes) cause…
AD to increase and shifts the IS curve to the right.
A cut in taxes
AD rises, IS curve shifts right
The IS curve represents
all combinations of income and interest rates for which the product market is in equilibrium.
If investment spending is interest insensitive then
the IS curve is also relatively interest insensitive.
Points to the left of the LM curve show
that the amount of money supplied exceeds money demand.
In calculating the IS curve, _____ is taken as exogenous
the price level
If people increase their expected rate of interest, the speculative demand for money curve will _____ and money supply will _____.
shift downward, remain unchanged.
In the Keynesian money market, velocity is
positively related to the interest
If the consumption function is given by C = 100 + 0.75(Y-T), then an increase of 10 units in taxes will cause the IS schedule to shift to the right by
-30 units.
A decline in the money stock will
shift the LM schedule to the right.
In the Keynesian theory, an exogenous decrease in the demand for money shifts
the LM curve to the left.
An decrease in the velocity of money for given levels of income and the interest rate would shift the
LM curve up.
If the consumption function is given by C = 200 + 0.6YD, then an increase in taxes of 50 units will cause the IS schedule to
shift to the left by 75 units.
If the money demand function is given by Md = 10 + 0.2Y ? 10r then a 10-unit increase in the quantity of money will cause the LM schedule to shifts to
the right by 50 units.
If the MPC is 0.6, then a 50-unit rise in taxes and a 50-unit rise in government spending will shift the IS curve
to the right by 50 units.
According to Keynes’ theory of money demand, a low interest rate increases the likelihood of a capital ________ and ______ the interest elasticity of money demand.
loss on bonds; reduces.
The LM curve slopes upward because
as income increases, money demand rises, which increases interest rates.
Assume that the economy is presently in equilibrium. A decline in the interest rate
increases planned investment, aggregate demand, and equilibrium income.
The IS curve slopes upward because
as income rises, savings rise and consumption falls, decreasing output.
Along any IS curve
both government spending and expectations are fixed.
Assume that you purchased a $1,000 perpetual bond that pays a market interest rate of 5 percent. If you attempted to sell this bond today subsequent to an increased market rate of interest of 7.5 percent, then you
could only sell this bond at a capital loss.
According to the Keynesian model of the money market, the supply of money
is chosen by the central bank.
In the Keynesian theory of money demand,
money is held in part because it is an asset.
The intuition behind the slope of the LM curve is that
as income increases, money demand increases which increases interest rates.
At any point on the LM curve
money supply equals money demand.
If Y>C+I+G but Md= Ms, then
both interest rates and output must fall.
A decrease in the price level, holding the nominal money supply constant, will shift the LM curve
upward and to the right.
Panel (a) in Figure 6.1 depicts
low interest elasticity of money demand.
Panel (b) in Figure 6.1 reflects
money demand to be highly interest elastic.
The IS curve represents
all points where there is no excess demand or excess supply.
Assuming that money demand is completely interest insensitive, the
LM schedule will be vertical.
In the IS-LM model, the two variables that are affected by the interest rate are
money demand and investment spending.
Points to the left of the LM schedule show that
the amount of money supplied exceeds the amount of money demanded.
If the current interest rate increases,
there is a movement along the money demand curve and the money supply curve remains unchanged.
Points to the right of the IS schedule indicate that
saving plus taxes will exceed investment plus government spending.
In the Keynesian system, an increase in the money stock would
decrease the interest rate, which, in turn, would increase aggregate demand and incom
One of the most responsive components of investment to changes in interest rates are
residential housing.
If Md = 1,000 - 400r and Ms = 2,000, the MPC = .85, G=100, and T = 120, then the equilibrium interest rate is
2.5
If Md = 2,600 - 200r, the MPC = .75, G=100, and T = 100. If the central bank wants the interest rate to be r=2, then the money supply must be
3,000
If the central bank follows a monetary policy in which it maintains a fixed interest rate, then
the LM curve will become horizontal.
If savings does not depend upon the interest rate, then
the IS curve is still downward sloping.
With respect to the Keynesian liquidity trap, at very low levels of income, equilibrium in the money market occurs at points along the flat portion of the money demand schedule where
the elasticity of money demand is extremely high.
If Y=C+I+G but Md< Ms, then
interest rates must fall and output must rise.
In the classical model,
neither fiscal nor monetary policy can influence output.
If money demand is not responsive to changes in interest rates, then
the LM curve is vertical.
A relatively steep money demand schedule reflects the assumption that the interest elasticity of money demand is
low (in absolute value).
Which of the following is true about the LM curve?
The LM cuve slopes upward for a given level of the money supply.
If the money supply increases at the same time that taxes increase, then:
interest rates will definitely decrease.
The IS curve will shift to the right if:
taxes decrease.
If the economy is in a liquidity trap, then:
monetary policy cannot stimulate the economy by lowering interest rates.
