Macroeconomics, 5ce

Chapter 5: Goods and Financial Markets: The IS-LM Model

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Chapter 5 Goods and Financial Markets: The IS-LM Model

1) The IS represents:
A) the single level of output where financial markets are in equilibrium.
B) the combinations of output and the interest rate where the money market is in equilibrium.
C) the combinations of output and the interest rate where the goods market is in equilibrium.
D) the single level of output where the goods market is in equilibrium.
E) the single level of output where both the goods market and the money market are in
equilibrium.
Answer: C
Diff: 1 Type: MC
Skill: Recall
Section Ref.: 5-1

2) The IS curve will shift to the left when which of the following occurs?
A) a reduction in taxes
B) an increase in interest rates
C) an increase in consumer confidence
D) an increase in taxes
E) an increase in government spending
Answer: D
Diff: 1 Type: MC
Skill: Recall
Section Ref.: 5-1

3) Which of the following occurs as the economy moves rightward along the IS curve?
A) A reduction in the interest rate causes investment spending to increase.
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 Macroeconomics, 5ce
Chapter 5: Goods and Financial Markets: The IS-LM Model

B) An increase in taxes causes a reduction in demand for goods.

C) A reduction in the interest rate causes an increase in the money supply.
D) An increase in government spending causes an increase in demand for goods.
E) A reduction in the interest rate causes money demand to increase.
Answer: A
Diff: 1 Type: MC
Skill: Recall
Section Ref.: 5-1

Copyright © 2015 Pearson Canada Inc. 5-2

 Macroeconomics, 5ce
Chapter 5: Goods and Financial Markets: The IS-LM Model

4) The LM represents:
A) the single level of output where financial markets are in equilibrium.
B) the combinations of output and the interest rate where the money market is in equilibrium.
C) the combinations of output and the interest rate where the goods market is in equilibrium.
D) the single level of output where the goods market is in equilibrium.
E) the single level of output where both the goods market and the money market are in
equilibrium.
Answer: B
Diff: 1 Type: MC
Skill: Recall
Section Ref.: 5-2

5) The LM curve will shift when which of the following occurs?

A) an increase in output
B) an open market sale of bonds
C) a reduction in taxes
D) an increase in government spending
E) a reduction in government spending
Answer: B
Diff: 1 Type: MC
Skill: Recall
Section Ref.: 5-2

6) Which of the following occurs as the economy moves rightward along the LM curve?
A) An increase in output causes an increase in money demand.
B) A reduction in the interest rate causes an increase in the money supply.
C) An increase in output causes an increase in demand for goods.
D) A reduction in the interest rate causes money demand to increase.
E) A reduction in the interest rate causes investment spending to increase.
Answer: A
Diff: 1 Type: MC
Skill: Recall
Section Ref.: 5-2

7) Suppose the economy is currently operating on both the LM curve and the IS curve. Given
this information, we know that:
A) only the goods market is in equilibrium.
B) only the money market is in equilibrium.
C) the bond market and financial markets are in equilibrium.
D) the goods market and the money market are in equilibrium.
E) the bond market and money market are in equilibrium.
Answer: D
Diff: 1 Type: MC
Skill: Recall
Section Ref.: 5-3

Copyright © 2015 Pearson Canada Inc. 5-3

 Macroeconomics, 5ce
Chapter 5: Goods and Financial Markets: The IS-LM Model

8) Suppose the economy is operating on the LM curve but not on the IS curve. Given this
information, we know that:
A) the money, bond and goods markets are all in equilibrium.
B) neither the money, bond, nor goods markets are in equilibrium.
C) the money market and bond markets are in equilibrium and the goods market is not in
equilibrium.
D) the goods market is in equilibrium and the money market is not in equilibrium.
E) the money market and goods market are in equilibrium but the bond market is not in
equilibrium.
Answer: C
Diff: 1 Type: MC
Skill: Recall
Section Ref.: 5-3

9) Suppose the economy is operating on neither the IS nor LM curve. Given this information, we
know that:
A) the goods market is in equilibrium.
B) the bond market is in equilibrium.
C) the money market is in equilibrium, but the goods market not is in equilibrium.
D) financial markets are in equilibrium, but the money market not is in equilibrium.
E) the goods market and the money market are not in equilibrium.
Answer: E
Diff: 1 Type: MC
Skill: Recall
Section Ref.: 5-3

10) A reduction in government spending will cause:

A) the IS curve to shift leftward.
B) the LM curve to shift down.
C) the IS curve to shift rightward.
D) the LM curve to shift up.
E) the IS curve to shift rightward, and the LM curve to shift up.
Answer: A
Diff: 1 Type: MC
Skill: Recall
Section Ref.: 5-1

11) After a contractionary fiscal policy:

A) the IS curve shifts and we move along the LM curve.
B) both the IS and LM curves shift.
C) neither the IS nor the LM curve shifts.
D) the LM curve shifts and we move along the IS curve.
E) output will change causing a change in money demand and a shift of the LM curve.
Answer: A
Diff: 1 Type: MC
Skill: Recall
Section Ref.: 5-1

Copyright © 2015 Pearson Canada Inc. 5-4

 Macroeconomics, 5ce
Chapter 5: Goods and Financial Markets: The IS-LM Model

12) An open market purchase of bonds will cause which of the following to occur?
A) The IS curve shifts rightward as the interest rate falls.
B) The LM curve shifts up.
C) The IS curve shifts leftward as the interest rate increases.
D) The LM curve shifts down.
E) The IS curve shifts rightward and the LM curve to remain the same.
Answer: D
Diff: 1 Type: MC
Skill: Recall
Section Ref.: 5-2

13) Based on our understanding of the IS-LM model, we know that a tax cut:
A) increases money demand and the interest rate.
B) must cause investment spending to increase.
C) could never affect investment spending.
D) must cause investment spending to decrease.
E) will reduce consumption and income.
Answer: A
Diff: 1 Type: MC
Skill: Applied
Section Ref.: 5-3

14) Suppose investment spending depends only on the interest rate and no longer depends on
output. Given this information, a reduction in government spending:
A) will cause investment to decrease.
B) will cause a reduction in output and have no effect on the interest rate.
C) will cause investment to increase.
D) will have no effect on investment.
E) will have no effect on output.
Answer: C
Diff: 2 Type: MC
Skill: Recall
Section Ref.: 5-1

15) If investment spending is very sensitive to the interest rate, then:

A) the IS curve should be relatively steep.
B) neither the IS nor the LM curve will be affected.
C) the IS curve should be relatively flat.
D) the LM curve should be relatively steep.
E) the LM curve should be relatively flat.
Answer: C
Diff: 2 Type: MC
Skill: Recall
Section Ref.: 5-1

Copyright © 2015 Pearson Canada Inc. 5-5

 Macroeconomics, 5ce
Chapter 5: Goods and Financial Markets: The IS-LM Model

16) If the demand for money is very sensitive to the interest rate, then:
A) the LM curve should be relatively steep.
B) the IS curve should be relatively flat.
C) the IS curve should be relatively steep.
D) the LM curve should be relatively flat.
E) neither the IS nor the LM curve will be affected.
Answer: D
Diff: 2 Type: MC
Skill: Recall
Section Ref.: 5-2

17) The "real money supply" is:

A) the money supply after subtracting counterfeit bills.
B) the stock of money measured in terms of goods, not dollars.
C) the actual quantity of money, rather than the officially reported quantity.
D) currency in circulation only.
E) the stock of high powered money only.
Answer: B
Diff: 1 Type: MC
Skill: Recall
Section Ref.: 5-2

18) An increase in the money supply will cause:

A) an increase in interest rate.
B) an increase in government spending.
C) an increase in taxes.
D) an increase in investment.
E) a reduction in government spending.
Answer: D
Diff: 1 Type: MC
Skill: Recall
Section Ref.: 5-2

19) Suppose there is a tax cut. Which of the following represents the complete list of variables
that must increase in response to this tax cut?
A) consumption and investment
B) consumption
C) consumption and output
D) consumption, investment and output
E) consumption, output and the interest rate
Answer: E
Diff: 1 Type: MC
Skill: Applied
Section Ref.: 5-1

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 Macroeconomics, 5ce
Chapter 5: Goods and Financial Markets: The IS-LM Model

20) Suppose there is a monetary contraction. Which of the following is a complete list of the
variables that must decrease?
A) consumption, output and investment
B) consumption and output
C) consumption
D) consumption and investment
E) consumption, output and the interest rate
Answer: A
Diff: 1 Type: MC
Skill: Applied
Section Ref.: 5-2

21) Suppose there is a simultaneous tax cut and open market sale of bonds. Which of the
following must occur as a result of this?
A) The interest rate increases.
B) Both output and the interest rate increase.
C) The interest rate decreases.
D) Output increases.
E) Output decreases.
Answer: A
Diff: 2 Type: MC
Skill: Applied
Section Ref.: 5-3

22) Suppose there is a simultaneous tax cut and open market purchase of bonds. Which of the
following must occur as a result of this?
A) The interest rate increases.
B) The interest rate decreases.
C) Output decreases.
D) Output increases.
E) Both output and the interest rate increase.
Answer: D
Diff: 2 Type: MC
Skill: Applied
Section Ref.: 5-3

23) Which of the following describes the Martin-Theissen policy mix in Canada?
A) expansionary fiscal, expansionary monetary
B) contractionary fiscal, expansionary monetary
C) contractionary fiscal, contractionary monetary
D) expansionary fiscal, contractionary monetary
E) balanced budget fiscal, contractionary monetary
Answer: B
Diff: 1 Type: MC
Skill: Recall
Section Ref.: 5-4

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 Macroeconomics, 5ce
Chapter 5: Goods and Financial Markets: The IS-LM Model

24) A reasonable dynamic assumption for the IS-LM model is that:

A) the economy is always on both the IS and LM curves.
B) the economy is always on the IS curve, but moves only slowly to the LM curve.
C) adjustment to the new IS-LM equilibrium is instantaneous after an LM shift, but not after an
IS shift.
D) the economy is always on the LM curve, but moves only slowly to the IS curve.
E) the money market is quick to adjust, but the bond market adjusts more slowly.
Answer: D
Diff: 1 Type: MC
Skill: Recall
Section Ref.: 5-4

25) If the central bank directly targets the interest rate in response to an increase in income, the
central bank will:
A) keep the money supply constant.
B) reduce the money supply.
C) increase the money supply.
D) reduce the target interest rate.
E) increase the target interest rate
Answer: C
Diff: 2 Type: MC
Skill: Recall
Section Ref.: 5-6

26) Suppose there is a policy mix of expansionary monetary policy and expansionary fiscal
policy. This combination of policies must cause:
A) an increase in output (Y).
B) a reduction in i.
C) a reduction in Y.
D) an increase in the interest rate (i).
E) an increase in investment (I).
Answer: A
Diff: 2 Type: MC
Skill: Applied
Section Ref.: 5-4

27) Suppose there is a policy mix of contractionary monetary policy and expansionary fiscal
policy. This combination of policies must cause:
A) an increase in output (Y).
B) an increase in the interest rate (i).
C) a reduction in i.
D) a reduction in Y.
E) an increase in consumption.
Answer: B
Diff: 2 Type: MC
Skill: Applied
Section Ref.: 5-4

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 Macroeconomics, 5ce
Chapter 5: Goods and Financial Markets: The IS-LM Model

28) Suppose there is a policy mix of expansionary monetary policy and contractionary fiscal
policy. This combination of policies must cause:
A) an increase in the interest rate (i).
B) a reduction in Y.
C) an increase in output (Y).
D) a reduction in i.
E) an increase in consumption.
Answer: D
Diff: 2 Type: MC
Skill: Applied
Section Ref.: 5-4

29) Suppose there is a policy mix of contractionary monetary policy and contractionary fiscal
policy. This combination of policies must cause:
A) an increase in investment (I).
B) an increase in output (Y).
C) an increase in the interest rate (i).
D) a reduction in i.
E) a reduction in Y.
Answer: E
Diff: 2 Type: MC
Skill: Applied
Section Ref.: 5-4

30) A tax cut must cause which of the following?

A) no change in investment
B) an increase in government spending
C) an increase in investment
D) an increase in consumption
E) a reduction in government spending
Answer: D
Diff: 1 Type: MC
Skill: Recall
Section Ref.: 5-1

31) A tax cut must cause which of the following?

A) no change in output if the central bank simultaneously pursues expansionary monetary policy
B) an increase in the interest rate and a reduction in investment
C) an increase in the interest rate and an ambiguous effect on investment
D) an increase in the interest rate and an increase in investment
E) an increase in the interest rate and an upward shift in the LM curve
Answer: C
Diff: 2 Type: MC
Skill: Recall
Section Ref.: 5-1

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 Macroeconomics, 5ce
Chapter 5: Goods and Financial Markets: The IS-LM Model

32) An increase in the money supply must cause which of the following?
A) an increase in investment and a rightward shift in the IS curve
B) a leftward shift in the IS curve
C) no change in output if investment is independent of the interest rate
D) a reduction in the interest rate and ambiguous effects on investment
E) no change in the interest rate if investment is independent of the interest rate
Answer: C
Diff: 1 Type: MC
Skill: Recall
Section Ref.: 5-2

33) A reduction in government spending will cause:

A) a downward shift in the LM curve.
B) a rightward shift in the IS curve.
C) an upward shift in the LM curve.
D) a leftward shift in the IS curve.
E) the IS and LM to remain the same.
Answer: D
Diff: 1 Type: MC
Skill: Recall
Section Ref.: 5-3

34) Assume that investment does NOT depend on the interest rate. A reduction in government
spending will cause which of the following for this economy?
A) no change in output
B) a reduction in output
C) no change in investment
D) an increase in investment
E) no change in the interest rate
Answer: B
Diff: 1 Type: MC
Skill: Recall
Section Ref.: 5-1

35) Assume that investment does NOT depend on the interest rate. A reduction in the money
supply will cause which of the following for this economy?
A) no change in the interest rate
B) a reduction in investment
C) an increase in investment
D) no change in output
E) an increase in output
Answer: D
Diff: 1 Type: MC
Skill: Recall
Section Ref.: 5-2

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 Macroeconomics, 5ce
Chapter 5: Goods and Financial Markets: The IS-LM Model

36) A reduction in consumer confidence will likely have which of the following effects?
A) a leftward shift in the IS curve
B) no change in the IS curve
C) a rightward shift in the IS curve
D) an upward shift in the LM curve
E) a downward shift in the LM curve
Answer: A
Diff: 2 Type: MC
Skill: Applied
Section Ref.: 5-3

37) An increase in the reserve deposit ratio, θ, will most likely have which of the following
effects?
A) a rightward shift in the IS curve
B) an upward shift in the LM curve
C) a downward shift in the LM curve
D) a leftward shift in the IS curve
E) no change in the LM curve
Answer: B
Diff: 2 Type: MC
Skill: Applied
Section Ref.: 5-3

38) A Bank of Canada purchase of securities will most likely have which of the following
effects?
A) a leftward shift in the IS curve
B) a downward shift in the LM curve
C) an upward shift in the LM curve
D) a rightward shift in the IS curve
E) no change in the LM curve
Answer: B
Diff: 2 Type: MC
Skill: Applied
Section Ref.: 5-2

39) An increase in government spending when there is an interest rate target leads to:
A) a decrease in output, an increase in the money supply, and no change in the interest rate.
B) an increase in output, the money supply, or the interest rate.
C) an increase in output, an increase in the money supply, and no change in the interest rate.
D) an increase in output, a decrease in the money supply, and a decrease in the interest rate.
E) no change in output, the money supply, or the interest rate.
Answer: C
Diff: 2 Type: MC
Skill: Applied
Section Ref.: 5-6

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 Macroeconomics, 5ce
Chapter 5: Goods and Financial Markets: The IS-LM Model

40) An increase in the aggregate price level, P, will most likely have which of the following
effects?
A) a rightward shift in the IS curve
B) no change in the LM curve
C) a downward shift in the LM curve
D) a leftward shift in the IS curve
E) an upward shift in the LM curve
Answer: E
Diff: 2 Type: MC
Skill: Applied
Section Ref.: 5-2

41) The IS curve will NOT shift when which of the following occurs?
A) a reduction in consumer confidence
B) a reduction in the interest rate
C) a reduction in government spending
D) an increase in government spending
E) an increase in consumer confidence
Answer: B
Diff: 2 Type: MC
Skill: Applied
Section Ref.: 5-1

42) Which of the following best defines the IS curve?

A) illustrates the effects of changes in i on investment
B) the combinations of i and Y that maintain equilibrium in financial markets
C) illustrates the effects of changes in i on desired money holdings by individuals
D) the combinations of i and Y that maintain equilibrium in the goods market
E) the combinations of i and Y that maintain equilibrium in both the goods market and financial
markets
Answer: D
Diff: 1 Type: MC
Skill: Recall
Section Ref.: 5-1

43) Which of the following best defines the LM curve?

A) illustrates the effects of changes in i on desired money holdings by individuals
B) the combinations of i and Y that maintain equilibrium in the goods market
C) the combinations of i and Y that maintain equilibrium in financial markets
D) illustrates the effects of changes in i on investment
E) the combinations of i and Y that maintain equilibrium in both the goods market and financial
markets
Answer: C
Diff: 1 Type: MC
Skill: Recall
Section Ref.: 5-2

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 Macroeconomics, 5ce
Chapter 5: Goods and Financial Markets: The IS-LM Model

44) Based on our understanding of the IS-LM model that takes into account dynamics, we know
that a reduction in the money supply will cause:
A) an immediate increase in i and no initial change in Y.
B) an immediate drop in Y and immediate increase in i.
C) a gradual increase in i and gradual reduction in Y.
D) an immediate reduction in i and no initial change in Y.
E) a gradual reduction in i and gradual reduction in Y.
Answer: A
Diff: 2 Type: MC
Skill: Recall
Section Ref.: 5-4

45) Based on our understanding of the IS-LM model that takes into account dynamics, we know
that a reduction in government spending will cause:
A) a gradual increase in i and gradual reduction in Y.
B) an immediate reduction in i and no initial change in Y.
C) a gradual reduction in i and an immediate reduction in Y.
D) an immediate drop in Y and immediate increase in i.
E) a gradual reduction in i and gradual reduction in Y.
Answer: E
Diff: 2 Type: MC
Skill: Recall
Section Ref.: 5-4

Suppose that the following equations describe an economy:

C = 170 + 0.60YD MS = 735; P = 1 T = 200

I = 100 - 4i Md = 0.75Y - 6i G = 350

46) The equation for equilibrium in the goods market is:

A) Y = 1250 + 10i.
B) Y = 980 + 8i.
C) Y = 980 - 8i.
D) Y = 1250 - 10i.
E) Y = 1250 + 8i.
Answer: D
Diff: 2 Type: MC
Skill: Applied
Section Ref.: 5-3

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 Macroeconomics, 5ce
Chapter 5: Goods and Financial Markets: The IS-LM Model

47) The equation for equilibrium in the financial markets:

A) Y = 1250 + 10i.
B) Y = 980 + 8i.
C) Y = 980 - 8i.
D) Y = 1250 - 10i.
E) Y = 1250 + 8i.
Answer: B
Diff: 2 Type: MC
Skill: Applied
Section Ref.: 5-3

48) The equilibrium level of output (Y), the interest rate (i), investment (I) and consumption (C)
are, respectively:
A) Y = 1200; i = 15; I = 40; C = 710.
B) Y = 1100; i = 5; I = 40; C = 700.
C) Y = 1100; i = 15; I = 40; C = 710.
D) Y = 1200; i = 15; I = 20; C = 710.
E) Y = 1000; i = 10; I = 40; C = 600.
Answer: C
Diff: 2 Type: MC
Skill: Applied
Section Ref.: 5-3

49) Suppose that the Bank of Canada sought to achieve the equilibrium level of output Y = 1140
through expansionary monetary policy alone. By how much would the Bank of Canada have to
increase the money supply?
A) 23
B) 72
C) 44
D) 38
E) 54
Answer: E
Diff: 3 Type: MC
Skill: Applied
Section Ref.: 5-3

50) Suppose that G increases by 36 to 386. The new IS curve is given by:
A) Y = 1340 - 8i.
B) Y = 1340 - 10i.
C) Y = 1340 + 10i.
D) Y = 1250 - 10i.
E) Y = 1250 + 8i.
Answer: B
Diff: 3 Type: MC
Skill: Applied
Section Ref.: 5-3

Copyright © 2015 Pearson Canada Inc. 5-14