IS-LM P2

Question 1

Initially we assumed when looking at Keynesian cross that it was fixed but in reality know that it depends on interest rate

Answer 1

Now

Question 2

Learn diagram deriving IS-LM curve?

Answer 2

Now

Question 3

What does IS-LM stand for?

Answer 3

Investment-saving liquidity-money

Question 4

How is r determined in the short run?

Answer 4

Theory of liquidity preference = a theory that suggests that the interest rate adjusts to bring the money supply and demand into balance

Question 5

How does the ToLP assume interest rate adjusts?

Answer 5

Adjusts by the supply and demand of the most liquid asset in the economy tf money

Question 6

The money supply (M) is determined by the CB. What is it’s important characteristic?

Answer 6

Not the nominal value of M, but the amount of G+S that can be bought with M

Question 7

Draw supply of real money balances curve?

Answer 7

Now

Question 8

Why is Supply of M vertical?

Answer 8

M is set by CB tf doesn’t depend on r

P is unaffected by r since in SR prices are sticky

Tf M/P doesn’t depend on r

Question 9

Explain why the demand for real money balances has the shape it has?

Answer 9

• people prefer to hold cash since it can be used to buy G+S
• tf amount of cash depends on r since r is the opportunity cost of holding cash
• tf an increase in r raises the opportunity cost of holding money tf reducing the quantity of real money balances demanded

Question 10

Draw demand and supply of real money balances diagram and show how it is used to derive the LM curve?

Answer 10

Now

Question 11

Draw demand and supply of real money balances diagram and show how r is kept in equilibrium?

Answer 11

Now

Question 12

What happens to keep r in balance if r>r(e)?

Answer 12

Increase deposits -> excess supply of funds tf decrease in r

Question 13

What does the demand for real money balances depend on and why and function?

Answer 13

(M/P)^d = L(r,Y)

Interest rate as described before

Income since increase income -> increase consumption -> increase cash demanded

Question 14

When does equilibrium in the money market occur?

Answer 14

When M/P (fixed) = L(r,Y)

Question 15

What does the LM curve show?

Answer 15

That when income goes up, so does the real interest rate

Question 16

Draw IS-LM diagram?

Answer 16

Now

Question 17

For SR equilibrium in IS-LM, what two markets must be in eq?

Answer 17

Money market

G+S market

Question 18

How would expansionary fiscal policy affect the IS-LM diagram and vice versa?

Answer 18

Expansionary FP -> increase in AE^P tf shifts IS curve right

Vice versa

Question 19

Why does expansionary FP affect AE^P? (2)

Answer 19

Increase G means increase in G^P

Since C=C(Y-T) a fall in T means an increase in C^P

Question 20

Why does a change in G cause an even greater change in Y?

Answer 20

Government purchaser multiplier

SEE DIAGRAM of AE^P shifting up

Question 21

How does contractionary FP shift the IS curve?

Answer 21

Left

Question 22

See page 7.

Answer 22

Now

Question 23

How do changes in monetary policy affect the LM curve? Use a diagram to explain?

Answer 23

Fall Supply of M -> upward shift of LM curve

Increase Supply of M -> downward shift of LM curve

For a fixed income, the interest rate changes tf LM curve must shift

Question 24

See crowding out effect diagram

Answer 24

Now

Question 25

See page 11 (policy interactions)

Answer 25

Now