# 178.

200 Intermediate Macroeconomics

Tutorial (4)

IS – LM Model I

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True or False Questions • According to Keynesian cross, the difference between actual and planned expenditure is the marginal propensity to consume MPC. Answer: F. Hint: The difference between actual and planned expenditure is unplanned inventory investment. (See P259&P262)

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(continued)

E Y>E Y=E E

Y<E

YE

Y

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True or False Questions (2) An decrease in government purchases shifts IS curve to the right by ΔG/(1-MPC). Answer: F. Hint: An decrease in government purchases shifts IS curve to the left by ΔG/(1-MPC). (See P269)

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True or False Questions (3) Either IS curve or LM curve can determine the level of income Y and the interest rate r. Answer: F. Hint: The level of income Y and the interest rate r determined when IS curve and LM curve intersected. (See P277)

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True or False Questions (4) The supply curve for real money balances is vertical because the central bank controls the supply of money through open-market operations. Answer: T. Hint: The supply curve for real money balances is vertical because the supply does not depend on the interest rate. (See P272)

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True or False Questions (5) More accurately, the nominal interest rate determines money demand and the real interest rate determines investment. Answer: T. Hint: (See P272).

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True or False Questions (6) The government – purchases multiplier

implies that the bigger the MPC is, the higher the equilibrium income level would be. Answer: T. Hint: (See P263).

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∆Y 1 = ∆G 1 − MPC

**Multiple-Choice Questions
**

(1) In the Keynesian cross model, the 45-degree line indicates that: b. GDP rises whenever consumption rises. c. actual expenditure is always equal to income. d. the equilibrium level of income increases whenever actual income increases. e. all of the above. Answer: b. Hint: (See P261).

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**Multiple-Choice Questions
**

(2) If income exceeds planned expenditure, firms will cut back production because unplanned inventory accumulation will be: b. positive. c. negative. d. zero. e. indeterminate. Answer: a. Hint: (See P262).

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**Multiple-Choice Questions
**

(3) If the consumption function is C = 100 + 0.8 (Y – T), the government-purchases multiplier is: c. 0.8. d. 1.25. e. 4. f. 5. Answer: d. Hint: (ΔY/ΔG = 1/ (1-0.8) = 10/2 = 5)

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**Multiple-Choice Questions
**

(4) If the consumption function is C = 100 + 0.8 (Y – T) and taxes decrease by $1, the equilibrium level of income will: c. decrease by $5. d. decrease by $4. e. increase by $5. f. increase by $4. Answer: d. Hint: (ΔY = (-MPC*ΔT)/(1-MPC) = -0.8*(-1)/0.2)

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**Multiple-Choice Questions
**

(5) According to the quantity equation MV = PY. If velocity is constant, the: b. LM curve will slope upward. c. LM curve will slope downward. d. LM curve will be horizontal. e. LM curve will be vertical. Answer: d. Hint: (See PP275-276).

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**Multiple-Choice Questions
**

(6) A normal LM curve can be derived from the quantity equation if it is assumed that: b. a higher interest rate reduces money demand and raises velocity. c. a higher interest rate reduces both money demand and velocity. d. velocity is constant. e. the price level is constant. Answer: a. Hint: (See P276)

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**Multiple-Choice Questions
**

(2005 Exam Question) (7) If investment, taxes, and government purchases are held constant, the planned expenditure curve: b. slopes upward and its slope is equal to the MPC. c. slopes downward and its slope is equal to the MPC. d. is a 45-degree line. e. is a vertical line. Answer: a. Hint: (See P260).

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**Multiple-Choice Questions
**

(2005 Exam Question) (8) At the equilibrium level of income: b. unintended inventory accumulation is equal to zero. c. planned expenditure is equal to actual expenditure. d. there is no tendency for GDP to change. e. all of the above. Answer: d. Hint: (See P261).

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**Multiple-Choice Questions
**

(2005 Exam Question)

(9) The FALSE statement below is: • a decrease in the interest rate increases planned investment. • a decrease in the interest rate shifts the planned expenditure curve upward. • a decrease in the interest rate shifts the IS curve to the right. • as the interest rate falls, planned expenditure is equal to actual expenditure at a higher level of income. Answer: c. Hint: (See 277)

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**Multiple-Choice Questions
**

(2005 Exam Question) (10) An increase of $1 in government purchases will: b. shifts the planned expenditure curve upward by $1. c. shifts the IS curve to the right by $1/(1-MPC). d. not shift the LM curve. e. all of the above. Answer: d. Hint: (See P269)

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**Multiple-Choice Questions
**

(2005 Exam Question) (11) According to the loanable funds interpretation of the IS curve: b. firms want to invest more as their income rises. c. banks want to lend more as the interest rate rises. d. an increase in income raises saving and lowers the interest rate that equilibrates the supply of and demand for loanable funds. e. all of the above. Answer: c. Hint: (See P270) 19

**Multiple-Choice Questions
**

(2005 Exam Question) (12) A decrease in taxes will shift the planned expenditure curve________ and the IS curve to the__________. b. upward, left. c. upward, right. d. downward, left. e. downward, right. Answer: b. Hint: (See P269)

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**Multiple-Choice Questions
**

(2005 Exam Question)

(13) The following statement about the LM curve is TRUE: b. the LM curve slopes upward and it is drawn for a given level of income. c. the LM curve slopes downward and an increase in price shifts it upward. d. the LM curve slopes upward and it is drawn for a given supply of real money balances. e. along the LM curve, actual expenditure is equal to planned expenditure. Answer: c. Hint: (See P275).

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**Multiple-Choice Questions
**

(2005 Exam Question) (14) An increase in the money supply shifts the: b. LM curve upward (to the left). c. LM curve downward (to the right). d. IS curve to the right. e. IS curve to the left. Answer: b. Hint: (See P276).

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**Multiple-Choice Questions
**

(2005 Exam Question) (15) At the intersection of the IS and LM curves: b. actual expenditure is equal to planned expenditure. c. real money supply is equal to real money demand. d. the levels of Y and r satisfy both the goods market equilibrium condition and the money market equilibrium condition. e. all of the above. Answer: d. Hint: (See PP277-278)

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Numerical Questions

(1) (Question 5 on Page 280) Suppose that the money demand function is where r is the interest rate in percent. The money supply M is 1,000 and the price level P is 2. Graph the supply and demand for real money balance. What is the equilibrium interest rate? Assume that the price level is fixed. What happens to the equilibrium interest rate if the supply of money is raised from 1,000 to 1,200? If the Fed wishes to raise the interest rate to 7 24 percent, what money supply should it set?

( M / P ) d = 1,000 − 100r

e. f. g. h.

**Numerical Questions Answer
**

a. M

r

s

(M/P)s

= 1000, P =2 ⇨

d

( M / P) = 500

**10 5 (M/P)d 500 M/P 1000
**

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( M / P ) = 1000 − 100r

Numerical Questions

Answer

b.

( M / P) = ( M / P)

d

s

1000 – 100r = 500 r = 5.

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**Numerical Questions Answer
**

c. M

= 1200, P =2 ⇨ ( M / P ) = 600

s

( M / P ) = 1000 − 100r

d

**600 = 1000 – 100r 100r = 400 r = 4%.
**

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**Numerical Questions Answer d s d. ( M / P ) = ( M / P )
**

M / P = 1000 –100r where P = 2, r = 7. Then M / 2 = 1000 – 100•7 M = 600. Nominal money supply reduced from 1000 to 600.

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Numerical Questions

r 10 7 5 (M/P)s1 (M/P)s0

300

500

(M/P)d 1000

M/P

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**Numerical Questions (2) Suppose that the following equations describe an economy: C = 170 + 0.6(Y – T) T = 200 I = 100 – 4r G = 350
**

( M / P ) d = L = 0.75Y − 6r ( M / P ) = M / P = 735

s

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Numerical Questions • Derive the equation for the IS curve. Answer: IS: Y = C(Y – T) + I(r) + G Y = 170 + 0.6(Y – 200) + 100 – 4r +350 0.4Y = 500 – 4r Y = 1250 – 10r.

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Numerical Questions b. Derive the equation for the LM curve. Answer: s d LM: ( M / P ) = ( M / P )

**735 = 0.75Y – 6r Y = 980 + 8r
**

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Numerical Questions c. Now express both the IS and LM equation in terms of r, and calculate their slopes. Answer: IS: r = 125 – (1/10)Y. LM: r = -122.5 + (1/8)Y Slope for IS is –0.1. Slope for LM is 0.125.

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Numerical Questions d. Use the equation from Parts a and b to calculate the equilibrium levels of output, the interest rate, planned investment, and consumption. Answer: Y = 1250 − 10r Y = 1100, r = 15%. I = 40, C = 710.

Y = 980 + 8r

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