Questions on IS-LM Model

B.S.Misra
A change in which of the following will NOT shift the IS-curve?

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1 Autonomous investment
2 Autonomous money demand
3 Autonomous consumption
4 Autonomous net exports
5 Autonomous saving

Correct Answer: 2
In an IS-LM model, if the government enacts restrictive fiscal policy through
a tax increase or a cut in government purchases,

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•1 The interest rate will decline, lowering the incentive to save and thus
also the level of investment spending
•2 The level of income will decrease but the interest rate will increase
•3 Both income and the interest rate will decrease
•4 The LM-curve will shift to the left
•5 The IS-curve will shift to the left, followed by a shift of the LM-curve
to the left since this policy will change interest rates and therefore money
demand

Correct Answer: 3
In an IS-LM model, any point that is to the left and below the IS-curve
indicates a situation where

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•1 There is excess demand for goods and services in the expenditure
sector
•2 There is excess supply of goods and services in the expenditure sector
•3 The expenditure sector is in equilibrium but the money sector is not
•4 There is excess demand for money in the money sector
•5 There is excess supply of money in the money sector

Correct Answer: 1
If the quantity of money demanded exceeds the quantity supplied at
the current interest rate, then

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•1 Bond prices and the interest rate will both rise
•2 Bond prices and the interest rate will both fall
•3 Bond prices will rise and the interest rate will fall
•4 Bond prices will fall and the interest rate will rise
•5 The value of both stocks and bonds will increase

Correct Answer: 4
Monetary policy becomes less effective as

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•1 The marginal propensity to consume increases
•2 The interest sensitivity of money demand decreases
•3 The interest sensitivity of investment decreases
•4 The LM-curve becomes steeper
•5 The IS-curve becomes flatter

Correct Answer: 3
When the LM-curve is vertical,

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• 1 The monetary policy multiplier is zero
• 2 Monetary policy is at its weakest but fiscal policy has a maximum effect on income
• 3 Monetary policy has a maximum effect, but fiscal policy has no effect on income
• 4 Monetary policy has a maximum effect, but fiscal policy has no effect on income
• 5 Monetary policy has a maximum effect, but fiscal policy has no effect on income

Correct Answer: 3
The transmission mechanism between an open market purchase by the
central bank and an increase in aggregate demand can break down if

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•1 Banks are unwilling to lend to private firms
•2 Money demand is totally interest inelastic
•3 Investment is very interest sensitive
•4 Bond prices increase too much
•5 None of the above

Correct Answer: 1
If investment is not very sensitive to interest rate changes,
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• 1 Fiscal policy will be largely ineffective in changing output
• 2 Monetary policy will be very effective in changing output
• 3 The economy is in the classical case
• 4 Monetary policy cannot be used to lower interest rates
• 5 The size of the crowding out effect following expansionary fiscal
policy will be small

Correct Answer: 5
Fiscal policy becomes more powerful in changing the level of output as
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• 1 Investment becomes more interest elastic
• 2 Money demand becomes more interest inelastic
• 3 Money demand becomes more income elastic
• 4 The marginal propensity to save gets smaller
• 5 The marginal propensity to consume gets smaller

Correct Answer: 4
Crowding out occurs when

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•1 An increase in defense spending causes a decrease in consumption
•2 Expansionary monetary policy fails to stimulate economic growth
•3 Expansionary fiscal policy causes interest rates to rise, thereby
reducing private spending
•4 Tax increases result in a drop in consumption
•5 A policy designed to increase the budget surplus causes the economy
to enter a recession

Correct Answer: 3
Assume you would like to stimulate investment but leave the level of
GDP roughly the same. What policy mix would you propose?
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• 1 An income tax cut combined with monetary expansion
• 2 A tax cut combined with monetary restriction
• 3 A cut in government spending combined with monetary
expansion
• 4 A cut in government spending combined with monetary
restriction
• 5 An investment subsidy combined with monetary expansion

Correct Answer: 3