18 Questions
What is the long-run effect of an increase in the money supply on the interest rate?
The interest rate remains unchanged in the long run.
Under a fixed-exchange-rate system, what happens to the real exchange rate in the long run?
The real exchange rate is free to vary.
What is the primary argument in favor of a floating-exchange-rate system?
It allows monetary policy to be used for other purposes.
What is the effect of a decrease in government spending on the overall economy?
It leads to a decrease in the interest rate.
What is the result of a devaluation of a currency under a fixed-exchange-rate system?
The value of the currency decreases.
What is the short-run effect of an increase in the money supply on income and interest rates?
Income increases, and the interest rate decreases.
What is the main goal of the Keynesian cross model?
To show the equilibrium of aggregate income and expenditure
What is the effect of an increase in government spending on income in the Keynesian-cross model?
It has a multiplying effect on income due to the consumption function
Which of the following is a characteristic of the liquidity preference theory?
The demand for money is inversely related to the interest rate
What is the effect of an increase in the money supply on the interest rate in the liquidity preference model?
The interest rate decreases to maintain equilibrium
What is the equilibrium interest rate in the liquidity preference model when the money demand function is (M / P)d = 2,200 – 200r, the money supply M is 2,000, and the price level P is 2?
10%
What is the primary role of fiscal policy in the Keynesian-cross model?
To stabilize the economy through government spending and taxation
If the MPC is 0.6 and there are no income taxes, a decrease in lump-sum taxes by 200 will lead to a shift in the IS curve by:
120
An increase in investment demand due to more optimistic expectations will lead to a _____ in the interest rate and a _____ in output.
decrease; increase
A higher price level in the economy will lead to a _____ real money supply and a _____ interest rate.
lower; higher
According to the graph, if the economy starts at short-term equilibrium D, the long-run equilibrium will be at _____ with a _____ price level.
B; higher
A given increase in government spending will shift the IS curve more to the right if the:
MPC is larger
If the MPC is 0.8, a decrease in lump-sum taxes by 100 will lead to an increase in output by:
450
Study Notes
Keynesian Cross Model
- The Keynesian cross shows the equilibrium of income and planned expenditure in the short run.
- Fiscal policy has a multiplying effect on income because it changes income, which changes consumption, which further changes income.
Liquidity Preference Model
- The supply of real money balances decreases as the interest rate increases.
- The interest rate adjusts to move the money market to equilibrium following a change in the money supply.
Money Demand Function
- The money demand function is (M / P)d = 2,200 – 200r, where r is the interest rate in percent.
- The equilibrium interest rate is determined by the money demand function.
Fiscal Policy and IS Curve
- A decrease in lump-sum taxes (T) shifts the IS curve to the right by the amount of the tax decrease multiplied by the marginal propensity to consume (MPC).
IS-LM Framework
- An increase in investment demand for any given level of income and interest rates increases output and raises interest rates.
- An increase in the money supply increases output and lowers the interest rate in the short run.
Aggregate Demand Curve
- The aggregate demand curve slopes downward and to the right because a higher price level causes a lower real money supply, which raises the interest rate and reduces spending.
Short Run to Long Run
- The long-run equilibrium will be at a higher price level and lower output compared to the short-run equilibrium.
Effects of Tax Increase and Government Spending
- A given increase in taxes shifts the IS curve more to the left the larger the marginal propensity to consume.
- An increase in government spending shifts the IS curve to the right.
Effects of Money Supply Increase
- An increase in the money supply increases income and lowers the interest rate in both the short run and in the long run.
Fixed-Exchange-Rate System
- In the long run, the nominal exchange rate is fixed, but the real exchange rate is free to vary under a fixed-exchange-rate system.
- A devaluation of a currency under a fixed-exchange-rate system occurs when the level at which the currency is fixed is decreased.
Floating-Exchange-Rate System
- One argument favoring a floating-exchange-rate system is that it allows monetary policy to be used for other purposes.
Test your understanding of the Keynesian Cross model, a fundamental concept in macroeconomics. Evaluate your knowledge of equilibrium income, interest rates, and fiscal policy in the short and long run.
Make Your Own Quizzes and Flashcards
Convert your notes into interactive study material.
Get started for free
