The IS-LM model

Question 1

What determines output in the short run according to the IS-LM model?

Answer 1

Equilibrium in the goods and financial market

The IS-LM model illustrates the interaction between the goods market and financial market.

Question 2

What is the formula for investment in the IS-LM model?

Answer 2

I = I(Y, i)

Investment depends on output (Y) and interest rate (i).

Question 3

What is the IS relation in the goods market?

Answer 3

Y = C(Y - T) + I(Y, i) + G

This equation represents the equilibrium condition where output (Y) equals the total demand.

Question 4

Who are the economists associated with the IS-LM model?

Answer 4

John Hicks and Alvin Hansen

They developed the framework for the IS-LM model.

Question 5

In the IS-LM model, what happens to equilibrium output when interest rates rise?

Answer 5

Equilibrium output decreases

A higher interest rate leads to a decrease in investment (I) and thus lowers output (Y).

Question 6

What is the relationship between output (Y) and demand for goods (Z) in the IS-LM model?

Answer 6

Demand for goods Z is an increasing function of output Y

This reflects the idea that higher output leads to higher income and thus greater demand.

Question 7

What does the IS curve represent?

Answer 7

The relationship between interest rates and output in the goods market

The IS curve is downward sloping, indicating that higher interest rates lead to lower output.

Question 8

Fill in the blank: The LM relation expresses that real money supply equals _______.

Answer 8

real money demand

Real money demand depends on real income (Y) and the interest rate (i).

Question 9

What effect does an increase in taxes (T) have on the IS curve?

Answer 9

Shifts the IS curve to the left

An increase in taxes reduces disposable income, leading to lower consumption and output.

Question 10

What is the effect of a monetary expansion on the LM curve?

Answer 10

Shifts the LM curve down

A decrease in the interest rate resulting from increased money supply leads to higher output.

Question 11

What is fiscal policy’s impact on the IS curve during a fiscal expansion?

Answer 11

Shifts the IS curve to the right

Increasing government spending or decreasing taxes raises aggregate demand.

Question 12

True or False: The IS-LM model assumes that output adjusts instantaneously to changes in interest rates.

Answer 12

False

The model acknowledges that output adjustment takes time.

Question 13

What is the outcome of combining fiscal contraction with monetary expansion?

Answer 13

Allows for deficit reduction without a recession

This combination can stabilize the economy while addressing fiscal concerns.

Question 14

What does an increase in government expenditure do to the IS curve?

Answer 14

Shifts the IS curve to the right

Higher government spending increases overall demand in the economy.

Question 15

What does the LM curve represent in the context of financial markets?

Answer 15

The relationship between real money supply and interest rates

It shows how changes in money supply affect equilibrium interest rates.

Question 16

What is the implication of a downward-sloping IS curve?

Answer 16

An increase in interest rates leads to a decrease in output

This reflects the inverse relationship between interest rates and investment.

Question 17

What happens to investment (I) when interest rates (i) increase?

Answer 17

Investment decreases

Higher interest rates typically discourage borrowing and investment.

Question 18

Fill in the blank: The equilibrium in the goods market occurs where _______.

Answer 18

Z = Y

This means that total demand for goods equals total output.

Question 19

What does an increase in the interest rate do to the demand for goods at any level of output?

Answer 19

Decreases the demand for goods

This leads to a decrease in the equilibrium level of output.

Question 20

What is the effect of monetary contraction on the LM curve?

Answer 20

Shifts the LM curve up

This occurs due to a decrease in the money supply, raising interest rates.

Question 21

What is the role of the Central Bank in the modern representation of the LM curve?

Answer 21

Chooses the interest rate and adjusts the money supply accordingly

This reflects a more active monetary policy approach.

Question 22

How does the IS-LM model illustrate the effects of fiscal and monetary policies?

Answer 22

By showing shifts in the IS and LM curves

These shifts illustrate changes in equilibrium output and interest rates.

Question 23

What is the relationship between private saving (S) and government deficit (T - G) in the context of fiscal consolidation?

Answer 23

Higher T - G can lead to higher I if S remains constant

However, a fiscal contraction can lower output, reducing private saving.

Question 24

What does empirical evidence suggest about the effects of an increase in the federal funds rate?

Answer 24

Leads to a decrease in output and an increase in unemployment

However, it has little effect on the price level in the short run.

Question 25

What is the effect of an increase in the federal funds rate on output in the short run?

Answer 25

It leads to a decrease in output ## Footnote This effect is observed in the US during the 1980-1998 period.

Question 26

What happens to unemployment when the federal funds rate is increased?

Answer 26

It increases ## Footnote This is a short-run effect observed alongside the decrease in output.

Question 27

In the short run, how does an increase in the federal funds rate affect the price level?

Answer 27

It has little effect on the price level.

Question 28

What is the analytical IS-LM model used for?

Answer 28

It analyzes the interaction between the goods market and the financial market.

Question 29

What is the equation for consumption (C) in the IS-LM model?

Answer 29

C = C(Y) = c + c1Y - c2i ## Footnote Where c, c1, and c2 are parameters.

Question 30

What is the general form of the IS equation in the IS-LM model?

Answer 30

Y = C(Y - T) + I(Y, i) + G

Question 31

What is the condition for the parameters in the IS-LM model?

Answer 31

c > 0; 0 < c < 1; d0, d1, d2 > 0; c + d < 1

Question 32

What is the IS curve in the IS-LM model?

Answer 32

It represents the equilibrium in the goods market.

Question 33

What does the LM curve represent in the IS-LM model?

Answer 33

It represents the equilibrium in the financial market.

Question 34

Fill in the blank: The IS-LM equilibrium is defined by the equation Y = _______ + I(Y, i) + G.

Answer 34

C(Y - T)

Question 35

What does the fiscal multiplier indicate in the IS-LM model?

Answer 35

The change in output (ΔY) resulting from a change in public spending or taxes.

Question 36

What is the formula for the change in output due to a change in public spending or taxes?

Answer 36

ΔY = Δ(G - c1T) / (1 - c1 - c2)

Question 37

What is the monetary policy multiplier in the IS-LM model?

Answer 37

It measures the change in output resulting from a change in the interest rate.

Question 38

What is the formula for the change in output due to a change in the interest rate?

Answer 38

ΔY = - (c2 / (1 - c1 - c2)) Δi

Question 39

True or False: The fiscal multiplier is the same as the monetary policy multiplier.

Answer 39

False