IS-MP model

Question 1

What does the IS-MP model represent

Answer 1

It captures equilibrium in the goods and money markets, showing how income and interest rates are jointly determined

Question 2

Why is the IS schedule negatively sloped

Answer 2

Higher output requires higher aggregate demand for equilibrium, and a lower interest rate is needed to boost aggregate demand

Question 3

What factors shift the IS curve

Answer 3

Changes in government expenditure (G), taxes (T), and expectations of future income growth

Question 4

What does the MP schedule depict

Answer 4

Money market equilibrium, showing how the central bank adjusts interest rates based on income levels

Question 5

What does a rightward shift in the MP curve indicate

Answer 5

A looser monetary policy, where the central bank sets lower interest rates for any level of income

Question 6

How does fiscal expansion affect the IS-MP model

Answer 6

It shifts the IS curve to the right, increasing income and interest rates, leading to potential crowding out of private investment

Question 7

Why do interest rates rise with fiscal expansion

Answer 7

If the government finances spending by borrowing from the private sector, competition for savings drives up interest rates

Question 8

Does public spending always crowd out private investment

Answer 8

No, public investment can enhance productivity and stimulate private investment under certain economic conditions

Question 9

How can monetary and fiscal policies be coordinated

Answer 9

Expansionary fiscal policy can be paired with tight monetary policy or vice versa to stabilize output

Question 10

What happens when actual output exceeds potential output

Answer 10

A positive output gap occurs, generating inflationary pressures

Question 11

What factors limit the effectiveness of fiscal and monetary policies

Answer 11

Imperfect economic data, policy lags, monetary policy constraints, and high government debt levels

Question 12

What does the Ricardian Equivalence theory suggest

Answer 12

Rational consumers anticipate future tax increases due to government borrowing and adjust their spending accordingly

Question 13

Why are fiscal multipliers higher during economic recessions

Answer 13

During downturns, increased government spending has a stronger impact as private sector demand is weak