topic 2 & 3

Question 1

What does IS stand for in the IS-LM model?

Answer 1

Investment Savings

Question 2

What does LM stand for in the IS-LM model?

Answer 2

Liquidity Money

Question 3

What is the equation for total demand in the IS-LM model?

Answer 3

Z = C + I + G

Question 4

What is the investment function in the IS-LM model?

Answer 4

I = f(Y, i) = b0 + b1Y - b2i

Question 5

What do the variables Y and i represent in the investment function?

Answer 5

Y = income/output, i = interest rates

Question 6

What is the relationship between investment and output?

Answer 6

Investment is positively related to output

Question 7

What is the relationship between investment and interest rates?

Answer 7

Investment is negatively related to interest rates

Question 8

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

Answer 8

Multiplier = 1/(1-c1-b1)

Question 9

What is the effect of a high interest rate on the ZZ curve?

Answer 9

Downward shift in ZZ

Question 10

What is the effect of a low interest rate on the ZZ curve?

Answer 10

Upward shift in ZZ

Question 11

What happens to the IS curve when government spending rises?

Answer 11

Rightward shift in IS curve

Question 12

What happens to the IS curve when government spending falls?

Answer 12

Leftward shift in IS curve

Question 13

What does the LM curve represent?

Answer 13

The relationship derived from financial markets

Question 14

What does M represent in the LM curve?

Answer 14

Money = bank balances and cash

Question 15

What is the relationship between bonds and interest rates?

Answer 15

Bonds have a positive relationship with interest rates

Question 16

What does real money demand depend on?

Answer 16

• Level of transactions (PY) * Interest rate on bonds (i)

Question 17

What does the LM relation show?

Answer 17

Central bank base rate

Question 18

What causes a movement along the LM curve?

Answer 18

A shift in the real money demand curve

Question 19

What causes an up or down shift in the LM curve?

Answer 19

A change in the central bank rate

Question 20

What happens to output when government spending increases?

Answer 20

Output rises but interest rates remain unchanged

Question 21

What happens to output when interest rates rise?

Answer 21

Output falls

Question 22

What is the significance of nominal interest rates?

Answer 22

They don’t consider inflation and are set by the central bank

Question 23

What is the formula for calculating real interest rates?

Answer 23

R = base rate - expected inflation

Question 24

What happened to base rates after the financial crisis of 2008?

Answer 24

They fell to almost Zero

Question 25

What does the risk premium represent?

Answer 25

The extra interest rate charged on top of the base rate

Question 26

What was a major cause of the financial crisis in 2008?

Answer 26

Sub-prime lending with high-risk mortgages

Question 27

What effect did the rise in risk premium have on investment?

Answer 27

Decrease in investment, causing ZZ to shift downwards

Question 28

What measures were taken during the Great Recession policy response?

Answer 28

* Cut interest rates * Increase government investment

Question 29

What is the relationship between output and investment in the new IS relation?

Answer 29

Output (Y) is positively related to investment

Question 30

What is the effect of an increasing risk premium on investment?

Answer 30

Negatively related to investment

Question 31

What can cause banks to become insolvent during a financial crisis?

Answer 31

A lack of liquidity

Question 32

What is the capital ratio formula?

Answer 32

Capital ratio = Capital/Assets

Question 33

What is the leverage ratio formula?

Answer 33

Leverage ratio = Assets/Capital