IS-LM Model and National Income Determinants
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Questions and Answers

What does the IS curve represent in the IS-LM model?

  • The relationship between interest rate and total output for which the goods market is in equilibrium (correct)
  • The relationship between money supply and interest rate
  • The relationship between investment and government expenditure
  • The relationship between national income and money demand

What happens to equilibrium output when investment rises in the IS-LM model?

  • Equilibrium output becomes negative
  • Equilibrium output remains unchanged
  • Equilibrium output falls (correct)
  • Equilibrium output rises

What is the significance of the downward sloping IS curve in the IS-LM model?

  • It shows a negative relationship between investment and government expenditure
  • It represents the positive relationship between money supply and national income
  • It indicates a positive relationship between consumption and income
  • It signifies the negative relationship between interest rate and total output (correct)

What happens to planned investment spending as interest rate increases in the IS-LM model?

<p>Planned investment spending falls (A)</p> Signup and view all the answers

In the IS-LM model, what does Point 1 in Panel C represent?

<p>The resulting equilibrium of output Y corresponding to a particular interest rate (B)</p> Signup and view all the answers

What is represented by the line connecting the 3 points in Panel C of the IS-LM model?

<p>The upward sloping IS curve (B)</p> Signup and view all the answers

What causes the IS curve to shift to the right from IS to IS2?

<p>An increase in net exports (NX) (B)</p> Signup and view all the answers

What is the LM curve?

<p>A curve that shows the relationship between nominal interest rate and real income level for which the money market is in equilibrium. (A)</p> Signup and view all the answers

What causes the LM curve to shift to the right?

<p>An increase in nominal money supply (MS) (D)</p> Signup and view all the answers

What is the equilibrium point in the ISLM model?

<p>When IS and LM curves intersect at point E (A)</p> Signup and view all the answers

What happens to the LM curve when there is a fall in real income Y3 to Y2?

<p>The LM curve shifts to the right (D)</p> Signup and view all the answers

What is the relationship between interest elasticity of demand for money and effectiveness of monetary policy?

<p>The more elastic the demand for money, the more effective monetary policy will be (A)</p> Signup and view all the answers

What happens to the effectiveness of monetary policy when the IS curve is perfectly inelastic?

<p>Monetary policy becomes less effective (D)</p> Signup and view all the answers

In an ISLM model, which policy would lead to a greater change in real income?

<p>Fiscal Policy with a steep IS curve (D)</p> Signup and view all the answers

In an ISLM model, what happens when there's a government deficit and LM is steep?

<p>The government deficit results in complete crowding out of private investment (C)</p> Signup and view all the answers

Which factor would lead to a large change in real income in an ISLM model?

<p>Increase in investment spending with flat IS curve (A)</p> Signup and view all the answers

What effect does an increase in government expenditure have on real income and interest rates in an ISLM model with a steep IS curve?

<p>Large change in real income and small change in interest rates (B)</p> Signup and view all the answers

Flashcards

IS Curve

Represents the relationship between interest rates and total output in goods market equilibrium.

Investment Rise Impact

Equilibrium output decreases when investment increases in the IS-LM model.

Downward Sloping IS Curve

Indicates a negative relationship between interest rates and total output.

Interest Rate Increase Effect

As interest rates rise, planned investment spending decreases in the IS-LM model.

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Point 1 in Panel C

Represents equilibrium output Y at a specific interest rate in the IS-LM model.

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IS Curve Connection Line

The line that connects three points in Panel C represents the upward sloping IS curve.

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IS Curve Shift Right

Occurs due to an increase in net exports (NX) in the IS-LM model.

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LM Curve

Shows the relationship between nominal interest rates and real income for money market equilibrium.

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LM Curve Shift Right

Happens when there is an increase in nominal money supply (MS).

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Equilibrium Point

The intersection of IS and LM curves at point E in the IS-LM model.

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LM Curve Effect of Real Income Fall

The LM curve shifts to the right when real income decreases from Y3 to Y2.

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Interest Elasticity of Money Demand

The more elastic the demand for money, the more effective monetary policy becomes.

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Perfectly Inelastic IS Curve Effect

Makes monetary policy less effective in the IS-LM model.

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Greater Change in Real Income

Fiscal policy with a steep IS curve leads to a larger change in real income.

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Government Deficit Impact with Steep LM

Government deficit causes complete crowding out of private investment when LM is steep.

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Large Change in Real Income Factor

Result of an increase in investment spending with a flat IS curve.

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Government Expenditure Effect with Steep IS

Leads to a large increase in real income and small rise in interest rates.

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Study Notes

IS Curve in the IS-LM Model

  • Represents the combinations of interest rates and levels of real income where the goods market is in equilibrium
  • Downward sloping due to the negative relationship between interest rates and planned investment spending

Shifts in the IS Curve

  • A rightward shift from IS to IS2 occurs when investment rises, leading to an increase in equilibrium output
  • This shift is caused by an increase in planned investment spending at each interest rate

LM Curve in the IS-LM Model

  • Represents the combinations of interest rates and levels of real income where the money market is in equilibrium
  • Upward sloping due to the positive relationship between interest rates and the demand for money

Shifts in the LM Curve

  • A rightward shift occurs when the demand for money increases, leading to an increase in interest rates
  • This shift is caused by an increase in the demand for money at each level of real income

Equilibrium in the IS-LM Model

  • Occurs at the point where the IS and LM curves intersect
  • Represents the combination of interest rates and levels of real income where both the goods and money markets are in equilibrium

Effectiveness of Monetary Policy

  • The effectiveness of monetary policy is influenced by the interest elasticity of demand for money
  • A high interest elasticity of demand for money makes monetary policy more effective
  • A perfectly inelastic IS curve makes monetary policy ineffective

Fiscal Policy in the IS-LM Model

  • A government deficit leads to a rightward shift of the IS curve, resulting in an increase in equilibrium output
  • The steepness of the LM curve determines the impact of fiscal policy on real income
  • A steep LM curve leads to a larger change in real income in response to fiscal policy

Real Income and Interest Rates

  • An increase in government expenditure leads to an increase in real income and a decrease in interest rates in an IS-LM model with a steep IS curve

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ECO531 Chapter 8 IS-LM Model PDF

Description

This quiz covers the IS-LM model, national income determinants, and government control over money supply. Topics include the relationship between interest rate and total output, the IS-LM model equilibrium, and the effects of government spending and investment on the economy.

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