QUIZZ IS-LM model and Aggregate Demand in a Closed Economy PARTI 1. If the short-run aggregate supply curve is horizontal and the long-run aggregate supply curve is vertical, then a change in the money supply will change in the short run and change in the long run. A. only prices; only output B. only output; only prices C. both prices and output; only prices D. both prices and output; both prices and output 2. Ifa short-run equilibrium occurs at a level of output above the natural rate, then in the transition to the long run prices will and output will A. increase; increase B, decrease; dex se C. increase; deere D. decrease; increase 3. Ifa short-run equilibrium occurs at a level of output below the natural rate, then in the transition to the long run prices will and output will A. increase; increase B. decrease; decrease C. increase; decrease D. decrease; increase 4, Assume that the economy starts from long-run equilibrium. If the Federal Reserve increases the money supply, then increase(s) in the short run and inerease(s) in the long run. A. prices; output B. output; prices C. output; output D. prices; prices Which of the following is an example of a demand shock? a large oil-price increase . the introduction and greater availability of credit cards . a drought that destroys agricultural crops D. unions obtain a substantial wage increase6. If the short-run aggregate supply curve is horizontal, an increase in union aggressiveness that pushes wages and prices up will result in prices and output in the short run. A. higher; lower B. lower; higher C. higher; higher D. lower; lower 7. Starting from long-run equilibrium, if'a drought pushes up food prices throughout the economy, the Fed could move the economy more rapidly back to full employment output by: A. increasing the money supply, but at the cost of permanently higher prices. B. decreasing the money supply, but at the cost of permanently lower prices. C. increasing the money supply, which would restore the original price level. D. decreasing the money supply, which would restore the original price level. 8. If the demand for money increases, but the Fed keeps the money supply the same, then in the short run output will ‘A. fall and in the long run prices will remain unchanged. B. remain unchanged and in the long run prices will fall. C. remain unchanged and in the long run prices will remain unchanged. D. fall and in the long run prices will fall. 9. If Central Bank A cares only about keeping the price level stable and Central Bank B cares only about keeping output at its natural level, then in response to an exogenous decrease in the velocity of money: ‘A. both Central Bank A and Central Bank B should increase the quantity of money. B. Central Bank A should increase the quantity of money whereas Central Bank B should keep it stable. C. Central Bank A should keep the quantity of money stable whereas Central Bank B should increase it. D. both Central Bank A and Central Bank B should keep the quantity of money stable. 10, Assume that the long-run aggregate supply curve is vertical at Y = 3,000 while the short-run aggregate supply curve is horizontal at P = 1.0. The aggregate demand curve is Y = 2(M/P) and M = 1,500. a. If the economy is initially in long-run equilibrium, what are the values of P and Y? b. If M increases to 2,000, what are the new short-run values of P and Y? c. Once the economy adjusts to long-run equilibrium at M = 2,000, what are P and Y?11. Assume that the long-run aggregate supply curve is vertical at Y = 3,000 while the short-run aggregate supply curve is horizontal at P = 1.0. The aggregate demand curve is ¥ = 2(M/P) and M = 1,500. a, If the economy is initially in long-run equilibrium, what are the values of P and Y? , What is the velocity of money in this case? ©. Suppose because banks start paying interest on checking accounts, the aggregate demand function shifts to Y = (1.5)(M/P). What are the short-run values of P and Y? 4d, What is the velocity of money in this case? e. With the new aggregate demand function, once the economy adjusts to long-run equilibrium, what are P and Y? £. What is the velocity now? 12, Suppose you are an economist working for the Federal Reserve when droughts in the Southeast and floods in the Midwest substantially reduce food production in the United States. Use the aggregate demand-aggregate supply model to illustrate graphically your policy recommendation to accommodate this adverse supply shock, assuming that your top priority is maintaining full employment in the economy. Be sure to label: i. the axes; ii. the curves; iii. the initial equilibrium values; iv. the direction the curves shift; and v, the terminal equilibrium values. State in words what happens to prices and output as a combined result of the supply shock and the recommended Federal Reserve accommodation. 13. An economy is initially in long-run equilibrium. The introduction of an electronic payments system dramatically reduces the demand for money in the economy, a, What is the short-run impact on prices and output of the new system? b, What can the central bank do, if anything, to counteract the short-run changes in output and prices? c. Ifthe central bank does not take any policy actions, what will be the long-run impact of the electronic payments system on prices and output? PART 2 1. For the purposes of the Keynesian cross, planned expenditure consists of: A. planned investment. B. planned government spending C. planned investment and government spending. D. planned investment, government spending, and consumption expenditures. 2. Along an IS curve all of the following are always true except: A. planned expenditures equal actual expenditures, B. planned expenditures equal income. C. the demand for real balances equals the supply of real balances. D. there are no unplanned changes in inventories,3. When the LM curve is drawn, the quantity that is held fixed ‘A. the nominal money supply. B. the real money supply. C. government spending. D. the tax rate. 4, 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 5 a. Use the Keynesian-cross model to illustrate graphically the impact of an increase in the interest rate on the equilibrium level of income. Be sure to label: i. the axes; ii. the curves; iii. the initial equilibrium values; iv. the direction the curve shifts; and v. the terminal equilibrium, values. . Explain in words what happens to equilibrium income as a result of the increase in the interest rate. 6. In explaining the 2003 bill to cut taxes, President Bush is quoted as saying, “When people have more money, they can spend it on goods and services.” a. In the IS-LM model, will a tax cut change the money supply in the economy? Does a change in the money supply shift the IS or the LM curve? b. In the IS-LM model, does a tax cut shift the IS or the LM curve? c. Based on your answers in a and b, how can you reconcile the president's statement with economies? Can you suggest how his statement could be modified to be consistent with the IS— LM model? PART3 1. Inthe IS-LM model when taxation increases, in short-run equilibrium, the interest rate and output A. rises; falls B. rises; rises C. falls; rises D. falls; falls2. In the IS-LM model under the usual conditions in a closed economy, an increase in ‘government spending increases the interest rate and crowds out: A. prices. B. investment. C. the money supply. 3. In the IS-LM model when M rises but P remains constant, usual case the interest rate and output A. rises; falls B. rises; rises C. falls; rises D. falls; falls short-run equilibrium, in the 4, According to the IS-LM model, if Congress raises taxes but the Fed wants to hold the interest rate constant, then the Fed must the money supply. A. increase. B. decrease C. first increase and then decrease D. first decrease and then increase 5. An increase in the demand for money, at any given income level and level of interest rates, will, within the IS-LM framework, output and interest rates. A. increase; lower B. increase; raise D. lower; raise 6. The U.S. recession of 2001 can be explained in part by a declining stock market and terrorist attacks. Both of these shocks can be represented in the IS-LM model by shifting the curve to the A. LM; right B. LM; left C.IS; right D.IS; left7. One policy response to the U.S. economic slowdown of 2001 was tax cuts. This policy response can be represented in the IS-LM model by shifting the curve to the ALM; right B. LM; left C. IS; right D. IS; left 8. One policy response to the U.S. economic slowdown of 2001 was to increase money growth. ‘This policy response can be represented in the IS-LM model by shifting the curve to the A. LM; right B. LM; left C.IS; right D.IS; left 9. The aggregate demand curve generally slopes downward and to the right because, for any given money supply Ma higher price level P causes a real money supply M/P, which ___the interest rate and_____ spending. A. lower; raises; reduces B. higher; lowers; increases C.low D. higher; raises; reduces lowe ; increases 10, A change in income in the IS-LM model resulting from a change in the price level is represented by a aggregate demand curve, while a change in income in the IS-LM model for a given price level is represented by a aggregate demand curve. A. movement along the; shift in the B. shift in the; movement along the C. vertical; horizontal D. horizontal; vertical 11. If the short-run IS-LM equilibrium occurs at a level of income below the natural level of output, then in the long run the price level will » shifting the curve to the right and returning output to the natural level. A. increase; IS B. decrease; IS C. increase; LM D. decrease; LM Refer to the following graph for questions 12 and 13:acon Opt, 12. If the economy starts from a short-term equilibrium at A, then the long-run equilibrium will beat___witha___price level. A.B; higher B. B; lower C.C; higher D.C; lower 13. Based on the graph, if the economy starts from a short-term equilibrium at D, then the long- run equilibrium will be at__witha___price level A.B; higher B.B; lower C.C; higher D.C; lower 14, If the IS curve is given by Y = 1,700 — 100r and the LM curve is given by Y = 500 + 100r, then equilibrium income and interest rate are given by’ A. Y= 1,100, 1=6 percent, B. Y = 1,200, r=$ percent. C. Y= 1,000, r= 5 percent. D. ¥ = 1,100, r=5 percent. 15. Suppose that people finally realize that they must save a larger proportion of their income in order to retire and that they simultaneously begin to use new technology that allows them to reduce their holdings of real cash balances as a proportion of their income. Use the IS-LM model to illustrate graphically the impact of these two changes in household behavior on output and interest rates. Be sure to label: i. the axes; ii. the curves; iii. the initial equilibrium values; iv. the direction the curves shift; and v. the terminal equilibrium values.