Mini Test 1

Question 1

When comparing the investment multiplier in a closed-economy to the investment multiplier in an open-economy it can be concluded that

a. the multiplier in the open-economy will be larger than in the closed-economy
b. the multiplier in the open-economy will be smaller than in the closed-economy
c. the investment multiplier is always larger because investment is more volatile
d. both multipliers are the same
e. the size of the multiplier will be determined by Tobin’s q in both open and closed economies

Answer 1

b. the multiplier in the open-economy will be smaller than in the closed-economy

[Investment multiplier in closed economy is: ΔY = ΔI x [1/(1-mpc)]

Investment multiplier in open economy is: ΔY = ΔI x [1/(1-(mpc-z))]

Multiplier is smaller in open economy as 1 is divided by a larger number than in closed economy (there are 2 leakages – savings + imports). ]

Question 2

In the simple Keynesian model of a closed economy the equilibrium level of income is R300 billion and the marginal propensity to consume is 0.75. If taxes fall by R20 billion, what is the new equilibrium level of income?

a. R60 billion
b. R240 billion
c. R320 billion
d. R360 billion
e. R520 billion

Answer 2

d. R360 billion

[ΔY = ΔT x [-mpc/(1-mpc)]
       = -R20 x [-0.75/(1-0.75)]
       = -R20 x [-0.75/0.25]
       = -R20 x -3
       = R60
Initial income is 300 billion so new income =R300 billion + R60 billion = R360 billion ]

Question 3

Which of the following factors will cause the IS curve to shift?

a. a change in interest rates
b. a change in the level of taxes
c. an increase in Tobin’s q
d. both b and c
e. all of the above

Answer 3

d. both b and c

Change in taxes and change in Tobin’s q = move of the IS curve

Question 4

If desired demand falls due to an exogenously determined fall in investment then the IS curve will

a. shift to the left
b. shift to the right
c. become steeper
d. become flatter
e. be unaffected

Answer 4

a. shift to the left

[Start in equilibrium: desired demand = output.

Desired demand falls so output is now greater than desired demand (excess supply).

Firms cannot sell all they produce & inventories rise. Firms reduce output until output again = desired demand.

Note that interest rates have not changed but output and desired demand have fallen.

This means IS curve shifted to the left. ]

Question 5

The goods market is not in equilibrium at any point to the left of the IS curve. At such points

a. there is excess demand for goods, inventories fall, so firms increase output
b. there is excess demand for goods, inventories fall, so firms reduce output
c. there is excess supply of goods, inventories rise, so firms increase output
d. there is excess supply of goods, inventories rise, so firms reduce output
e. the supply and demand for goods are equal

Answer 5

a. there is excess demand for goods, inventories fall, so firms increase output

[To left of IS curve Desired demand > output (excess demand).

In such a situation inventories fall, and firms will increase output shifting us to the right to the IS curve.

Looking for the answer that has excess demand, falling inventories & firms increase output.]

Question 6

At any point to the right of the IS curve

a. desired demand exceeds supply therefore firms will reduce output
b. desired demand is less than supply therefore forms will increase output
c. government will increase its expenditure so that we return to the IS curve
d. desired demand exceeds supply therefore firms will increase output
e. desired demand is less than supply therefore firms will reduce output

Answer 6

e. desired demand is less than supply therefore firms will reduce output

[Excess supply, rising inventories, firms reduce output]

Question 7

Which of the following would cause the IS curve to shift to the RIGHT

i. an increase in government expenditure.
ii. a fall in taxes.
iii. a rise in household wealth
iv. a fall in Tobin’s q
v. a rise in interest rates

a. (i) and (ii)
b. (i), (ii) and (iii)
c. (ii) and (iii)
d. (ii) and (iv)
e. (ii), (iv) and (v)

Answer 7

b. (i), (ii) and (iii)

(i) , (ii) and (iii) cause IS to shift to the right.

Question 8

An increase in government spending

a. shifts the IS curve to the left by G x [(− mpc/(1 −mpc)]
b. shifts the IS curve to the left by G x [(1/(1 − mpc)]
c. shifts the IS curve to the right by G x [(1 – mpc)/(1 − mpc)]
d. shifts the IS curve to the right by G x [(1/(1 − mpc)]
e. does not shift the IS curve because taxes must rise

Answer 8

d. shifts the IS curve to the right by G x [(1/(1 − mpc)]

Increase in government spending shifts IS to right (Y=C+I+G increases). Multiplier is G x [(1/(1 − mpc)].