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• Zuka Kazalikashvili

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FINAL EXAM Chapter 5 Goods and Financial Markets; The IS-LM Model 1. Using the information in this chapter, label each of the following statements true, false, or uncertain. Explain briefly. a. The main determinants of investment are the level of sales and the interest rate. True. The main determinants of the level of investment are sales and the interest rate. First, sales determine the level of investment, because firms facing low sales will have little reason or ability to invest in extra capacity or additional machines. b. If all the exogenous variables in the IS relation are constant, then a higher level of output can be achieved only by lowering the interest rate. True. If all of the exogenous variables are controlled for, then lowering the interest rate would increase output. This is, in part, the theory behind expansionary monetary policy. c. The IS curve is downward sloping because goods market equilibrium implies that an increase in taxes leads to a lower level of output. False. The IS curve is downward sloping because goods market equilibrium, implies that an increase in the interest rate leads to decrease in output. d. If government spending and taxes increase by the same amount, the IS curve does not shift. False, it shifts to the right as the multiplier has an effect on equilibrium output. e. The LM curve is horizontal at the central bank’s policy choice of the interest rate. True, LM curve is horizontal at policy interest rate chosen by Central Bank f. The real money supply is constant along the LM curve. False. As output rises, the demand for real money rises and the central bank must increase the supply of real money to keep interest rates constant. g. If the nominal money supply is $400 billion and the price level rises from an index value of 100 to an index value of 103; the real money supply rises. False. The real money supply falls when the nominal money supply is constant and the price level rises. h. If the nominal money supply rises from $400 billion to $420 billion and the price level rises from an index value of 100 to 102, the real money supply rises. True. The nominal money supply rose by 10%. The price level rose by 2%. The ratio M/P increased. i. An increase in government spending leads to a decrease in investment in the IS-LM model.

True. An increase in government spending leads to a decrease in the level of investment. Investment is equal to private saving plus public saving. 2. Consider first the goods market model with constant investment that we saw in Chapter 3. Consumption is given by

C=c 0 +c 1 (Y −T ) ¿ I , G ,∧T are given . a. Solve for equilibrium output. What is the value of the multiplier for a change in autonomous spending? In equilibrium we know that

Y=

1 ( c −c T + I +G ) (1−c 1) 0 1

b. Solve for equilibrium output using the methods learned in Chapter 3. At a given interest rate, why is the effect of a change in autonomous spending bigger than what it was in part (a)? Why? (Assume c 1 +b1