17) An increase in money supply causes the real interest rate to ________ and output to
________ in the short run, before prices adjust to restore equilibrium.
A) rise; rise
B) rise; fall
C) fall; rise
D) fall; fall
18) Suppose the intersection of the IS and LM curves is to the left of the FE line. A decrease in
the price level would most likely eliminate a disequilibrium among the asset, labor, and goods
markets by
A) shifting the LM curve down and to the right.
B) shifting the IS curve up and to the right.
C) shifting the IS curve down and to the left.
D) shifting the FE curve to the left.
19) Suppose the intersection of the IS and LM curves is to the left of the FE line. What would
most likely eliminate a disequilibrium among the asset, labor, and goods markets?
A) A rise in the price level, shifting the LM curve up and to the left
B) A fall in the price level, shifting the LM curve down and to the right
C) A rise in the price level, shifting the IS curve up and to the right
D) A fall in the price level, shifting the IS curve down and to the left
20) Suppose the intersection of the IS and LM curves is to the right of the FE line. What would
most likely eliminate a disequilibrium among the asset, labor, and goods markets?
A) A rise in the price level, shifting the LM curve up and to the left.
B) A fall in the price level, shifting the LM curve down and to the right.
C) A rise in the price level, shifting the IS curve up and to the right.
D) A fall in the price level, shifting the IS curve down and to the left.
21) A temporary decrease in government purchases causes the real interest rate to ________ and
the price level to ________ in general equilibrium.
A) rise; rise
B) rise; fall
C) fall; rise
D) fall; fall
22) An increase in taxes (when Ricardian equivalence doesn’t hold) causes the real interest rate
to ________ and the price level to ________ in general equilibrium.
A) rise; rise
B) rise; fall
C) fall; rise
D) fall; fall
23) For each of the following changes, which equilibrium curve (IS, LM, or FE) is shifted? Draw
the change in the underlying demand or supply curves (for example, money demand and supply
for the LM curve) and show how the equilibrium curve changes.
(a) Expected inflation increases.
(b) The future marginal productivity of capital increases.
(c) Labor supply decreases.
(d) Future income declines.
(e) There’s a temporary beneficial supply shock.
(f) The nominal interest rate on money rises.
24) Oil prices have risen temporarily, due to political uncertainty in the Middle East. An advisor
to the Fed suggests, “Higher oil prices reduce aggregate demand. To offset this we must increase
the money supply. Then the price level won’t need to adjust to restore equilibrium, and we’ll
prevent a recession.” Analyze this statement using the IS—LM model.
25) For each of the following changes, what happens to the real interest rate and output in the
very short run, before the price level has adjusted to restore general equilibrium?
(a) Wealth rises.
(b) Money supply rises.
(c) The future marginal productivity of capital increases.
(d) Expected inflation declines.
(e) Future income declines.
19
26) Desired consumption is Cd = 2000 + 0.9Y – 100,000r – G, and desired investment is Id =
1000 – 45,000r. Real money demand is Md/P = Y – 6000i. Other variables are πe = 0.03, G =
500, = 1000, and M = 2100.
(a) Find the equilibrium values of the real interest rate, consumption, investment, and the price
level.
(b) Suppose government purchases decline to 400. What happens to the variables listed in part
(a)?
(c) Suppose government purchases rise to 600. What happens to the variables listed in part (a)?
(d) What feature in this example leads to the result that you don’t need to know the amount of
taxes collected by the government to find the equilibrium?
27) Desired consumption is Cd = 100 + 0.8Y – 500r – 0.5G, and desired investment is Id = 100 –
500r. Real money demand is Md/P = Y – 2000i. Other variables are πe = 0.05, G = 200, =
1000, and M = 2100.
(a) Find the equilibrium values of the real interest rate, consumption, investment, and the price
level.
(b) Suppose the money supply increases to 2800. Find the equilibrium values of the real interest
rate, consumption, investment, and the price level. (Assume that the expected inflation rate is
unchanged.)
Answer:
28) Analyze the following statement, and show what would happen in the long run if such advice
were followed by the Fed: “The increase in the stock market has increased people’s wealth. As a
result, their consumption has increased, increasing aggregate demand and output. So the Fed
needs to increase the money supply, since with higher income, people’s demand for real money
balances will be higher.”
29) Use the IS—LM model to determine the effects of each of the following on the general
equilibrium values of the real wage, employment, output, the real interest rate, consumption,
investment, and the price level.
(a) Tougher immigration laws reduce the working-age population.
(b) There’s increased volatility in the prices of stocks and bonds.
(c) The government tries to achieve tax equity by an increase in the corporate tax rate.
(d) Increased computerization reduces stock market brokerage costs.
30) Suppose the Federal Reserve’s short-run response to any change in the economy is to change
the money supply to maintain the existing real interest rate. What would happen to money supply
if there were a reduction in government purchases? Given the Fed’s policy, what would happen
in the very short run (before general equilibrium is restored) to output and the real interest rate?
What must happen to the LM curve and the price level to restore general equilibrium?
31) Suppose you were a forecaster of the real wage rate, employment, output, the real interest
rate, consumption, investment, and the price level. A shock hits the economy, which you think is
a temporary adverse supply shock.
(a) What are your forecasts for each of the variables listed above (rise, fall, and no change)?
(b) What if the shock was really due to people’s reduced expectations about their future income.
Which variables did you forecast correctly, and which did you forecast incorrectly?
Answer:
9.5 Price Adjustment and the Attainment of General Equilibrium
1) A decrease in money supply causes the real interest rate to ________ and output to ________
in the short run, before prices adjust to restore equilibrium.
A) rise; rise
B) rise; fall
C) fall; rise
D) fall; fall
2) An increase in money supply causes the real interest rate to ________ and the price level to
________ in general equilibrium.
A) rise; rise
B) remain unchanged; fall
C) remain unchanged; rise
D) fall; fall
3) A decrease in money supply causes the real interest rate to ________ and the price level to
________ in general equilibrium.
A) rise; rise
B) remain unchanged; fall
C) remain unchanged; rise
D) fall; fall
4) After a temporary adverse supply shock hits the economy, general equilibrium is restored by
A) a shift down and to the left of the IS curve.
B) a shift to the left of the FE line.
C) a shift up and to the left of the LM curve.
D) a shift down and to the right of the IS curve.
5) Suppose the intersection of the IS and LM curves is to the right of the FE line. An increase in
the price level would most likely eliminate a disequilibrium among the asset, labor, and goods
markets by
A) shifting the LM curve up and to the left.
B) shifting the IS curve up and to the right.
C) shifting the IS curve down and to the left.
D) shifting the FE curve to the left.
6) In classical IS—LM analysis, the effects of a decline in desired investment include
A) a decline in output.
B) an increase in the price level.
C) a decline in the real interest rate.
D) an increase in unemployment.
7) Classical economists think general equilibrium is attained relatively quickly because
A) the real interest rate adjusts quickly.
B) the level of output adjusts quickly.
C) the real wage rate adjusts quickly.
D) the price level adjusts quickly.
8) Keynesian economists think general equilibrium is not attained quickly because
A) the real interest rate adjusts slowly.
B) the level of output adjusts slowly.
C) the real wage rate adjusts slowly.
D) the price level adjusts slowly.
9) Classical economists believe that a market economy will normally
A) suffer from extended periods of sustained unemployment.
B) achieve full-employment output.
C) degenerate into pure monopolies in most industries.
D) eliminate the problem of economic scarcity.
10) Keynesian economists believe that in the short run
A) money neutrality exists and prices adjust rapidly.
B) money neutrality does not exist and prices adjust rapidly.
C) money neutrality exists and prices do not adjust rapidly.
D) money neutrality does not exist and prices do not adjust rapidly.
11) Classical economists believe that in the short run
A) money neutrality exists and prices adjust rapidly.
B) money neutrality does not exist and prices adjust rapidly.
C) money neutrality exists and prices do not adjust rapidly.
D) money neutrality does not exist and prices do not adjust rapidly.
12) Under monetary neutrality, an increase in the money supply causes output to ________ and
the price level to ________.
A) rise; rise
B) rise; not change
C) not change; not change
D) not change; rise
13) Under an assumption of monetary neutrality, a change in the nominal money supply has
A) no effect on the price level.
B) a less than proportionate effect on the price level.
C) a proportionate effect on the price level.
D) a more than proportionate effect on the price level.
14) Describe the differences between classical and Keynesian economists in terms of their views
about monetary neutrality.
15) For each of the following changes, what happens to the real interest rate and output in the
very short run, before the price level has adjusted to restore general equilibrium?
(a) Wealth declines.
(b) Money supply declines.
(c) The future marginal productivity of capital declines.
(d) Expected inflation rises.
(e) Future income rises.
Answer:
9.6 Aggregate Demand and Aggregate Supply
1) The aggregate demand curve shows
A) the demand for goods depending on the relative price of goods compared to financial assets.
B) the amount of output that can be obtained given the current production function in the
economy.
C) the relation between the aggregate quantity of goods demanded and the price level.
D) the relation between the real interest rate and output when the goods market clears.
2) The aggregate demand curve shows the combinations of output and the price level that put the
economy on
A) the FE line and the IS curve.
B) the FE line, the IS curve, and the LM curve.
C) the IS curve.
D) the IS curve and the LM curve.
3) The aggregate demand curve
A) is vertical.
B) slopes upward.
C) is horizontal.
D) slopes downward.
4) Which of the following changes shifts the AD curve down and to the left?
A) A temporary increase in government purchases
B) A rise in the nominal money supply
C) A decrease in corporate taxes
D) A decrease in consumer confidence
5) Which of the following changes shifts the AD curve down and to the left?
A) A decline in the nominal money supply
B) A decrease in income taxes
C) A decrease in the risk on nonmonetary assets
D) An increase in the future marginal productivity of capital
6) Which of the following changes shifts the AD curve up and to the right?
A) A rise in the nominal money supply
B) An increase in income taxes
C) An increase in the risk on nonmonetary assets
D) A decrease in the future marginal productivity of capital
7) Which of the following changes shifts the AD curve up and to the right?
A) A temporary decrease in government purchases
B) A decline in the nominal money supply
C) An increase in corporate taxes
D) An increase in consumer confidence
8) The aggregate supply curve shows the relation between
A) the real interest rate and the aggregate amount of output that firms supply.
B) the price level and the aggregate amount of output that firms supply.
C) the supply of goods by firms and the price of goods relative to the price of nonmonetary
assets.
D) the inflation rate and the unemployment rate.
9) The short-run aggregate supply curve (in the absence of misperceptions)
A) is vertical.
B) slopes upward.
C) is horizontal.
D) slopes downward.
10) The long-run aggregate supply curve
A) is vertical.
B) slopes upward.
C) is horizontal.
D) slopes downward.
11) Which of the following changes shifts the SRAS curve up?
A) An increase in the labor force
B) An increase in firms’ costs
C) A decrease in government purchases
D) An increase in the money supply
12) Which of the following changes shifts the SRAS curve up?
A) A decrease in the labor force
B) A decrease in the money supply
C) An increase in government purchases
D) An increase in firms’ costs
13) Which of the following changes shifts the long-run aggregate supply curve to the right?
A) A demographic change that increases the labor supply
B) A decrease in the demand for labor
C) An increase in consumer confidence
D) A decrease in taxes (assuming Ricardian equivalence doesn’t hold)
14) Which of the following changes shifts the SRAS curve down?
A) An increase in the labor force
B) An increase in the money supply
C) A decrease in government purchases
D) A decrease in firms’ costs
15) When the money supply rises by 10%, in the short run, output ________ and the price level
________.
A) rises; is unchanged
B) declines; falls
C) is unchanged; falls
D) declines; is unchanged
16) When the money supply declines by 10%, in the long run, output ________ and the price
level ________.
A) is unchanged; is unchanged
B) declines; falls
C) is unchanged; falls
D) declines; is unchanged
17) Describe the effects, in both the short run and the long run, of an increase in the money
supply. Explain what happens to real output and the price level.
18) For each outcome below, tell what type of shift must have taken place in either the aggregate
demand curve or the long-run aggregate supply curve.
(a) In the short run, the price level is unchanged and output rises.
(b) In the long run, the price level declines and output is unchanged.
(c) In the long run, the price level rises and output declines.