T1-Expenditure and Interest Rates

Question 1

What can be highlighted from UK GDP over the past few years? (2)

Answer 1

• Huge drop from Covid
• UK GDP very flat

Question 2

What does the IS-LM model allow us to analyse? (3)

Answer 2

1 output, consumption and investment
2 the interest rate
3 the money supply

Question 3

What type of economy are we considering atm with the IS-LM model?

Answer 3

Closed economy

Question 3

How can we explore the the IS-LM to see the effects of? (3)

Answer 3

1 fiscal policy (government expenditure and taxes)
2 monetary policy (interest rates and the money supply)
3 shocks, eg the Covid-19 pandemic

Question 4

Why is the IS-LM model not realistic?( 3)

Answer 4

1 is very stylised, expressing complex relationships in overly-simple ways
2 makes a number of unrealistic assumptions
3 most importantly, it assumes that prices are fixed; we cannot explain
inflation using IS-LM

Question 5

What is the IS relationship?

Answer 5

Reflects expenditure and how it is affected by interest rates

Question 6

Is IS demand or supply for goods?

Answer 6

Demand

Question 7

What is the LM relationship?

Answer 7

Reflects monetary policy

Question 8

What is the difference between endogenous and exogenous?

Answer 8

Endogenous is explained by the model, exogenous is not explained by the model.
Endogenous is not the same as fixed

Question 9

What is IS made up of?

Answer 9

National income
Consumption function
Investment function

Question 10

What do we assume is exogenous in IS?

Answer 10

Government expenditure

Question 11

What is the equation of national income?

Answer 11

Y = C + I + G

Question 12

What is the equation of the consumption function?

Answer 12

C = cY

c = paramter

Question 13

Why is the consumption function equation like this?

Answer 13

Can be derived from optimal behaviour

Question 14

What is the equation for the investment function?

Answer 14

I = Ibar - bi

Ibar = parameter
i = interest rate

Question 15

Is the interest rate endogenous or exogenous?

Answer 15

Endogenous???

Question 16

Combining all the equations hat make up the IS curve, what is the IS equation?

Answer 16

Y = [1/(1 − c)] x {I¯+ G} ]− b
1 − c
i

Question 17

Why does IS slope down?

Answer 17

Investment is determined via interest rates

Question 18

What shifts the IS curve?

Answer 18

Exogenous variables
- Government expenditure
- Real exchange rate
- Yworld

Question 19

What relationship does teh LM curve show?

Answer 19

Output and interest rates

Question 20

What three versions of the lm curve are there?

Answer 20

1 The classic LM curve, developed soon after
Keynes’ General Theory
2 A fixed interest rate
3 a monetary policy rule

Question 21

What is the classic LM curve based on?

Answer 21

Two relationships:
1 the demand for money
2 the supply of money

Question 22

What does money demand depend on?

Answer 22

Output and interest rates

Question 23

What is fixed in the LM curve?

Answer 23

Price level

Question 24

What is the equation of the money demand?

Answer 24

M / P = kY - hi

Question 25

What shifts the money demand curve?

Answer 25

Income (Y)

Question 26

What are on the axis of the money demand curve?

Answer 26

y axis - i
x axis - money demand

Question 27

In Classic LM, is money supply exogenous or endogenous?

Answer 27

Exogenous as set by the Central Bank

Question 28

What is the equation of the LM curve? (Classic)

Answer 28

M/P =kY - hi
i = k/h Y - 1/h x M/P

Question 29

What is the slope of the LM curve? (Classic)

Answer 29

k/h

Question 30

What shifts the LM curve? (Classic)

Answer 30

Money supply