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Solutions to the End-of-Chapter Questions and Problems
18.1 The IS Curve
Learning objective: Understand what the IS curve is and how it is derived.
Review Questions
1.1 The three parts of the IS-MP model are:
1. The IS curve, which shows the combinations of the real interest rate and aggregate output that
3. The Phillips curve, which shows the short-run relationship between the output gap (or the
1.2 At Y2, aggregate expenditure is less than real GDP and there is an unintended increase in
1.3 The multiplier in the simple model equals 1/(1 – MPC). The larger the MPC, the larger the
1.4 The IS curve represents equilibrium in the goods market because it shows the combinations of
1.5 An example of a shock that could shift the IS curve to the left would be a decline in the prices of
Problems and Applications
1.6 We know that at equilibrium, Y = C +
´
I+´
G+´
NX .
Substituting in the given values, we
have:
1.7 Disagree. The capacity of a firm is not the maximum output that the firm is capable of producing.
1.8 The real interest rate is held constant along any given aggregate expenditure line and, therefore,
1.9 a. Consumption spending will increase, so the IS curve will shift to the right.
1.10 The larger the multiplier, the flatter the IS curve. With a larger multiplier, any given change in
1.11 If consumption spending becomes more sensitive to changes in the real interest rate, the IS
1.12 The IS curve would be steeper during recessions because a given decline in the interest rate
would result in a smaller increase in planned investment spending and, in turn, a smaller
18.2 The MP Curve and the Phillips Curve
Learning objective: Explain the significance of the MP curve and the Phillips curve.
Review Questions
2.1 Short-term interest rates and long-term interest rates tend to rise and fall together, so changes in
2.2 The MP curve is a horizontal line because the model assumes that the Fed is able to keep the
2.5 Okun’s law is a statistical relationship between the output gap and the cyclical rate of
Problems and Applications
2.6 You should agree. Because they are adjusted for inflation, real interest rates represent the return
2.7 You should agree. Increases in expected inflation increase nominal interest rates, so nominal
2.8 a. The Fed can cause the real interest rate to increase or decrease by increasing or decreasing its
b. A decline in real interest rates reduces the cost of borrowing money to buy a home, which
2.9 a. A decrease in expected inflation would shift the short-run Phillips curve down, given the
c. A substantial decrease in the price of oil is a negative supply shock and would cause the
d. An increase in cyclically unemployment would cause a movement down along the
e. Favorable weather conditions resulting in bumper agricultural crops is a positive supply
2.10 a. Okun’s law is a statistical relationship between the output gap and the cyclical rate of
b. Firms worried that they might be forced into bankruptcy and took actions to cut their
2.12 a. Holding long-term nominal interest rate constant, a steady downward trend in expected inflation
b. To offset the rise in long-term real interest rates, the Fed could decrease its target for the
2.13 The higher natural rate of unemployment would shift both the unemployment rate version and
