Keynesian Economics (IS-LM model)

Question 1

What does the IS-LM model do?

Answer 1

• describes the equilibrium in the goods market and the money market
• determines general EQ in the economy

Question 2

What does IS and LM stand for?

Answer 2

• IS = Investment and Saving
• LM = Liquidity preference and Money

Question 3

What links the goods and money markets?

Answer 3

• interest rate (i)

Question 4

What does the IS curve show?

Answer 4

• the inverse relationship between interest rate and output

Question 5

What does the slope of the IS curve depend on?

Answer 5

• how responsive C and investment expenditures are to changes in interest rates and on the size of the multiplier

Question 6

The more responsive ___ and ____ are to interest rate changes, the ___ the IS curve

Answer 6

• consumption
• investment
• flatter

Question 7

What causes shifts in the IS curve?

Answer 7

• changes in autonomous expenditure

Question 8

What would government spending independent if any change in interest rates lead to?

Answer 8

• a shift of the IS curve to the right

Question 9

What would a fall in exports lead to?

Answer 9

• a shift of the IS curve to the left

Question 10

Where is the IS curve derived from?

Answer 10

• the Keynesian Cross diagram

Question 11

Where is the LM curve derived from?

Answer 11

• the money market diagram

Question 12

Why does the LM curve have a positive slope?

Answer 12

• it relates to the increase in income being associated with an increase in the interest rate and vice versa

Question 13

What does the slope of the LM curve depend on?

Answer 13

• how responsive the demand for money is to changes in interest rates

Question 14

The LM curve can shift if…

Answer 14

• the central bank increases or decreases the money supply

Question 15

Assuming income remains unchanged, a rise in money supply will…

Answer 15

• shift the LM curve to the right

Question 16

What would happen if the government reduces taxation to boost economic activity?

Answer 16

• the IS curve will shift to the right, both national income and interest rates will rise

Question 17

If the central bank wants to keep interest rates constant…

Answer 17

• they must expand the money supply and so the LM curve will shift to the right

Question 18

How to maintain interest rates constant following a rise in the IS curve?

Answer 18

• shift LM curve to the right to keep interest rate at old level
• this can be achieved by increasing the money supply