1.

John Maynard Keynes wrote that responsibility for low income and high unemployment
in economic downturns should be placed on:
A) low levels of capital.
B) an untrained labour force.
C) inadequate technology.
D) low aggregate demand.

2. According to classical theory, national income depends on ______, while Keynes

proposed that ______ determined the level of national income.
A) aggregate demand; aggregate supply
B) aggregate supply; aggregate demand
C) monetary policy; fiscal policy
D) fiscal policy; monetary policy

3. The basic ISñLM model takes ______ as exogenous.

A) the price level and national income
B) the price level
C) national income
D) the interest rate

4. The variable that links the market for goods and services and the market for real money
balances in the ISñLM model is the:
A) consumption function.
B) interest rate.
C) price level.
D) nominal money supply.

5. In the ISñLM model, which two variables are influenced by the interest rate?
A) supply of nominal money balances and demand for real balances
B) demand for real balances and government purchases
C) supply of nominal money balances and investment spending
D) demand for real money balances and investment spending

6. Two interpretations of the ISñLM model are that the model explains:
A) the determination of income in the short run when prices are fixed, or what shifts
the aggregate demand curve.
B) the short-run quantity theory of income, or the short-run Fisher effect.
C) the determination of investment and saving, or what shifts the liquidity preference
schedule.
D) changes in government spending and taxes or the determination of the supply of
real money balances.

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 7. The IS curve plots the relationship between the interest rate and ______ that arises in the
market for ______.
A) national income; goods and services
B) the price level; goods and services
C) national income; money
D) the price level; money

8. In the basic Keynesian cross analysis, planned expenditure consists of:

A) planned investment.
B) planned government spending.
C) planned investment and government spending.
D) planned investment, government spending, and consumption expenditures.

9. In the basic Keynesian-cross model, actual expenditures equal:

A) GDP.
B) the money supply.
C) the supply of real balances.
D) unplanned inventory investment.

10. In the Keynesian-cross model, actual expenditures differ from planned expenditures by
the amount of:
A) liquidity preference.
B) the government-purchases multiplier.
C) unplanned inventory investment.
D) real money balances.

11. Planned expenditure is a function of:

A) planned investment.
B) planned government spending and taxes.
C) planned investment, government spending, and taxes.
D) national income and planned investment, government spending and taxes.

12. When planned expenditure is drawn on a graph as a function of income, the slope of the
line is:
A) zero.
B) between zero and one.
C) one.
D) greater than one.

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 13. When drawn on a graph with Y along the horizontal axis and E along the vertical axis,
the line showing planned expenditures rises to the:
A) right with a slope less than one.
B) right with a slope greater than one.
C) left with a slope less than one.
D) left with a slope greater than one.

14. The equilibrium condition in the Keynesian-cross analysis in a closed economy is:
A) income equals consumption plus investment plus government spending.
B) planned expenditure equals consumption plus planned investment plus government
spending.
C) actual expenditure equals planned expenditure.
D) actual saving equals actual investment.

15. When firms experience unplanned inventory accumulation, they typically:

A) build new plants.
B) lay off workers and reduce production.
C) hire more workers and increase production.
D) call for more government spending.

16. With planned expenditure and the equilibrium condition Y = PE drawn on a graph with
income along the horizontal axis, if income exceeds expenditure, then income is to the
______ of equilibrium income and there is unplanned inventory ______.
A) right; decumulation
B) right; accumulation
C) left; decumulation
D) left; accumulation

17. According to the analysis underlying the Keynesian cross, when planned expenditure
exceeds income:
A) income falls.
B) planned expenditure falls.
C) unplanned inventory investment is negative.
D) prices rise.

18. The Keynesian cross shows:

A) determination of equilibrium income and the interest rate in the short run.
B) determination of equilibrium income and the interest rate in the long run.
C) equality of planned expenditure and income in the short run.
D) equality of planned expenditure and income in the long run.

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Use the following to answer questions 19-21:

Exhibit: Keynesian Cross

20. (Exhibit: Keynesian Cross) In this graph, if firms are producing at level Y1, then
inventories will ______ inducing firms to ______ production.
A) rise; increase
B) rise; decrease
C) fall; increase
D) fall; decrease

21. (Exhibit: Keynesian Cross) In this graph, if firms are producing at level Y3, then
inventories will ______ inducing firms to ______ production.
A) rise; increase
B) rise; decrease
C) fall; increase
D) fall; decrease

22. The government-purchases multiplier indicates how much ______ change(s) in response
to a $1 change in government purchases.
A) the budget deficit
B) consumption
C) income
D) real balances

23. In the Keynesian-cross model, if the MPC equals .75, then a $1 billion increase in

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 government spending increases planned expenditures by ______ and increases the
equilibrium level of income by ______.
A) $1 billion; more than $1 billion
B) $.75 billion; more than $.75 billion
C) $.75 billion; $.75 billion
D) $1 billion; $1 billion

24. According to the Keynesian-cross analysis, when there is a shift upward in the
government-purchases schedule by an amount DG and the planned expenditure schedule
by an equal amount, then equilibrium income rises by:
A) one unit.
B) DG.
C) DG divided by the quantity one minus the marginal propensity to consume.
D) DG multiplied by the quantity one plus the marginal propensity to consume.

25. In the Keynesian-cross model, if government purchases increase by 100, then planned
expenditures ______ for any given level of income.
A) increase by 100
B) increase by more than 100
C) decrease by 100
D) increase, but by less than 100

26. In the Keynesian-cross model, if government purchases increase by 250, then the
equilibrium level of income:
A) increases by 250.
B) increases by more than 250.
C) decreases by 250.
D) increases, but by less than 250.

27. In the Keynesian-cross model, fiscal policy has a multiplied effect on income because
fiscal policy:
A) increases the amount of money in the economy.
B) changes income, which changes consumption, which further changes income.
C) is government spending and, therefore, more powerful than private spending.
D) changes the interest rate.

28. According to the Keynesian-cross analysis, if MPC stands for marginal propensity to
consume, then a rise in taxes of DT will:
A) decrease equilibrium income by DT.
B) decrease equilibrium income by DT/(1 ñ MPC).
C) decrease equilibrium income by (DT)(MPC)/(1 ñ MPC).

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D) not affect equilibrium income at all.

29. In the Keynesian-cross model, if taxes are reduced by 100, then planned expenditures
______ for any given level of income.
A) increase by 100
B) increase by more than 100
C) decrease by 100
D) increase, but by less than 100

30. In the Keynesian-cross model, if taxes are reduced by 250, then the equilibrium level of
income:
A) increases by 250.
B) increases by more than 250.
C) decreases by 250.
D) increases, but by less than 250.

32. In the Keynesian-cross model with a given MPC, the government-expenditure multiplier
______ the tax multiplier.
A) is larger than
B) equals
C) is smaller than
D) is the inverse of the

33. In the Keynesian-cross model, if the MPC equals .75, then a $1 billion decrease in taxes
increases planned expenditures by ______ and increases the equilibrium level of income
by ______.
A) $1 billion; more than $1 billion
B) $.75 billion; more than $.75 billion
C) $.75 billion; $.75 billion
D) $1 billion; $1 billion

34. Both Keynesians and supply-siders believe a tax cut will lead to growth:
A) and both agree it works through incentive effects.
B) but Keynesians believe it works through incentive effects whereas supply-siders
believe it works through aggregate demand.
C) but Keynesians believe it works through aggregate demand whereas supply-siders
believe it works through incentive effects.
D) and both agree it works through aggregate demand.

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 35. Tax cuts stimulate ______ by improving worker's incentive and expand ______ by
raising households' disposable income.
A) velocity; demand for loanable funds
B) demand for loanable funds; velocity
C) aggregate demand; aggregate supply
D) aggregate supply; aggregate demand

36. In the Keynesian-cross model, the equilibrium level of income is determined by:
A) the factors of production.
B) the money supply.
C) planned spending.
D) liquidity preference.

37. In the Keynesian-cross model, what adjusts to move the economy to equilibrium
following a change in exogenous planned spending?
A) planned spending
B) the interest rate
C) production
D) the price level

39. All of the following items shrink the expenditure multiplier in the Keynesian-cross
model except:
A) savings.
B) imports.
C) transfers, such as Canada Pension Plan receipts.
D) taxes.

40. The Keynesian-cross analysis assumes planned investment:

A) is fixed and so does the IS analysis.
B) depends on the interest rate and so does the IS analysis.
C) is fixed, whereas the IS analysis assumes it depends on the interest rate.
D) depends on the interest rate unlike IS analysis which assumes planned investment is
fixed.

44. In the Keynesian-cross model, a decrease in the interest rate ______ planned investment
spending and ______ the equilibrium level of income.
A) increases; increases
B) increases; decreases
C) decreases; decreases
D) decreases; increases

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 45. When drawn on a graph with income along the horizontal axis and the interest rate
along the vertical axis, the IS curve generally:
A) is vertical.
B) is horizontal.
C) slopes upward and to the right.
D) slopes downward and to the right.

46. Along any given IS curve:

A) tax rates are fixed, but government spending varies.
B) government spending is fixed, but tax rates vary.
C) both government spending and tax rates vary.
D) both government spending and tax rates are fixed.

47. The IS curve shifts when all of the following economic variables change except:
A) the interest rate.
B) government spending.
C) tax rates.
D) the marginal propensity to consume.

48. An increase in government spending generally shifts the IS curve, drawn with income
along the horizontal axis and the interest rate along the vertical axis:
A) downward and to the left.
B) upward and to the right.
C) upward and to the left.
D) downward and to the right.

49. If investment does not depend on the interest rate, then the ______ curve is ______.
A) IS; vertical
B) IS; horizontal
C) LM; vertical
D) LM; horizontal

51. Along an IS curve all of the following are always true except:
A) planned expenditures equal actual expenditures.
B) planned expenditures equal income.
C) the demand for real balances equals the supply of real balances.
D) demand and supply of loanable funds are equal.

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 52. The IS curve shows combinations of ______ that are consistent with equilibrium in the
market for goods and services:
A) inflation and unemployment
B) the price level and real output
C) the interest rate and the level of income
D) the interest rate and real money balances

53. An interpretation of why the IS curve slopes downward and to the right is that as income
rises, national saving rises, and this increase drives the interest rate:
A) down, thereby decreasing investment.
B) down, thereby increasing investment.
C) up, thereby decreasing investment.
D) up, thereby increasing investment.

54. When drawn with the interest rate on the vertical axis and income on the horizontal axis,
the IS curve will be steeper the:
A) larger the level of government spending.
B) smaller the level of government spending.
C) greater the sensitivity of investment spending to the interest rate.
D) smaller the sensitivity of investment spending to the interest rate.

55. The slope of the IS curve depends on:

A) the interest sensitivity of investment and the amount of government spending.
B) the interest sensitivity of investment and the marginal propensity to consume.
C) the interest sensitivity of investment and the tax rates.
D) tax rates and government spending.

56. An increase in taxes shifts the IS curve, drawn with income along the horizontal axis
and the interest rate along the vertical axis:
A) downward and to the left.
B) upward and to the right.
C) upward and to the left.
D) downward and to the right.

57. Based on the Keynesian model, one reason to support spending increases over tax cuts
as measures to increase output is that:
A) government spending increases the MPC more than tax cuts.
B) the government-spending multiplier is larger than the tax multiplier.
C) government-spending increases do not lead to unplanned changes in inventories,

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 but tax cuts do.
D) increases in government spending increase planned spending, but tax cuts reduce
planned spending.

58. One argument in favour of tax cuts over spending on infrastructure to increase
production is that:
A) tax cuts increase the MPC by a larger amount than spending on infrastructure.
B) tax cuts increase planned spending, but spending on infrastructure offsets private
spending.
C) the tax multiplier is larger than the government spending multiplier.
D) it takes longer to implement spending on infrastructure than to implement tax cuts.

59. An IS curve shows combinations of:

A) taxes and government spending.
B) nominal money balances and price levels.
C) interest rates and income that bring equilibrium in the market for real balances.
D) interest rates and income that bring equilibrium in the market for goods and
services.

60. A given increase in taxes shifts the IS curve more to the left the:
A) larger the marginal propensity to consume.
B) smaller the marginal propensity to consume.
C) larger the government spending.
D) smaller the government spending.

61. If neither investment nor consumption depends on the interest rate, then the IS curve is
______ and ______ policy has no effect on output.
A) vertical; monetary
B) horizontal; monetary
C) vertical; fiscal
D) horizontal; fiscal

63. The IS curve may be interpreted as showing the:

A) interest rate that equates money supply and demand for given income.
B) income level that equates money supply and demand for given interest rate.
C) interest rate that equilibrates the market for loanable funds for given income.
D) amount of loanable funds that will be demanded for given interest rate and income.

64. In the loanable funds model, a decrease in income ______ national saving and ______
the equilibrium interest rate.

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 A) increases; increases
B) increases; decreases
C) decreases; decreases
D) decreases; increases

65. In the Keynesian-cross model, as the interest rate increases, the equilibrium level of
income ______, whereas in the loanable funds model, as the level of income increases,
the equilibrium level of the interest rate ______.
A) increases; increases
B) increases; decreases
C) decreases; decreases
D) decreases; increases

66. The IS curve generally determines:

A) income.
B) the interest rate.
C) both income and the interest rate.
D) neither income nor the interest rate.

Use the following to answer questions 67-69:

Exhibit: Keynesian Cross and Loanable Funds

67. (Exhibit: Keynesian Cross and Loanable Funds) Both graphs illustrate the inverse
relationship between the equilibrium interest rate and the equilibrium level of income.
The economy moves from equilibrium A to equilibrium B in the Keynesian-cross
diagram as a result of a(n) ______ that shifts planned expenditures.
A) increase in income
B) decrease in income

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C) increase in the interest rate
D) decrease in the interest rate

68. (Exhibit: Keynesian Cross and Loanable Funds) Both graphs illustrate the inverse
relationship between the equilibrium interest rate and the equilibrium level of income.
The economy moves from equilibrium A to equilibrium B in the Loanable Funds
diagram as a result of a(n) ______ that shifts saving.
A) increase in income
B) decrease in income
C) increase in the interest rate
D) decrease in the interest rate

69. (Exhibit: Keynesian Cross and Loanable Funds) Both graphs illustrate the inverse
relationship between the equilibrium interest rate and the equilibrium level of income.
Planned expenditures increase in the Keynesian-cross model as a result of ______, and
saving increases in the loanable funds model as a result of ______.
A) an increase in taxes; an increase in real money balances
B) a decrease in the interest rate; an increase in income
C) a decrease in velocity; an increase in government spending
D) an increase in the interest rate; a decrease in income

70. A rise in government spending shifts the IS curve because it ______ national saving for
any given level of income, and this ______ the interest rate for any given level of
income.
A) reduces; reduction lowers
B) reduces; reduction raises
C) increases; increase raises
D) increases; increase lowers

71. When the LM curve is drawn, the quantity that is held fixed is:
A) the nominal money supply.
B) the real money supply.
C) government spending.
D) the tax rate.

72. According to the theory of liquidity preference, the supply of real money balances:
A) decreases as the interest rate increases.
B) increases as the interest rate increases.
C) increases as income increases.
D) is fixed.

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 73. According to the theory of liquidity preference, the supply of nominal money balances:
A) is chosen by the central bank.
B) depends on the interest rate.
C) varies with the price level.
D) changes as the level of income changes.

74. The theory of liquidity preference implies that:

A) as the interest rate rises, the demand for real balances will fall.
B) as the interest rate rises, the demand for real balances will rise.
C) the interest rate will have no effect on the demand for real balances.
D) as the interest rate rises, income will rise.

75. If the interest rate is above the equilibrium value, the:

A) demand for real balances exceeds the supply.
B) supply of real balances exceeds the demand.
C) market for real balances clears.
D) demand for real balances increases.

76. According to the theory of liquidity preference, if the supply of real money balances
exceeds the demand for real money balances, individuals will:
A) sell interest-earning assets in order to obtain non-interest-bearing money.
B) purchase interest-earning assets in order to reduce holdings of non-interest-bearing
money.
C) purchase more goods and services.
D) be content with their portfolios.

77. According to the theory of liquidity preference, if the demand for real money balances
exceeds the supply of real money balances, individuals will:
A) sell interest-earning assets in order to obtain non-interest-bearing money.
B) purchase interest-earning assets in order to reduce holdings of non-interest-bearing
money.
C) purchase fewer goods and services.
D) be content with their portfolios.

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Use the following to answer questions 78-80:

Exhibit: Market for Real Money Balances

79. (Exhibit: Market for Real Money Balances) Based on the graph, if the interest rate is r1,
then people will ______ bonds and the interest rate will ______.
A) sell; rise
B) sell; fall
C) buy; rise
D) buy; fall

80. (Exhibit: Market for Real Money Balances) Based on the graph, if the interest rate is r3,
then people will ______ bonds and the interest rate will ______.
A) sell; rise
B) sell; fall
C) buy; rise
D) buy; fall

81. The theory of liquidity preference implies that, other things being equal, an increase in
the real money supply will:
A) lower the interest rate.
B) raise the interest rate.
C) have no effect on the interest rate.
D) first lower and then raise the interest rate.

83. According to the theory of liquidity preference, tightening the money supply will

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 ______ nominal interest rates in the short run, and according to the Fisher effect,
tightening the money supply will ______ nominal interest rates in the long run.
A) increase; increase
B) increase; decrease
C) decrease; decrease
D) decrease; increase

84. Reducing the money supply ______ nominal interest rates in the short run, and ______
nominal interest rates in the long run.
A) produces no change in; raises
B) raises; produces no change in
C) raises; lowers
D) lowers; raises

85. In the liquidity preference model, what adjusts to move the money market to
equilibrium following a change in the money supply?
A) planned spending
B) the interest rate
C) production
D) the price level

86. The theory of liquidity preference implies that the quantity of real money balances
demanded is:
A) negatively related to both the interest rate and income.
B) positively related to both the interest rate and income.
C) positively related to the interest rate and negatively related to income.
D) negatively related to the interest rate and positively related to income.

87. With the real money supply held constant, the theory of liquidity preference implies that
a higher income level will be consistent with:
A) no change in the interest rate.
B) a lower interest rate.
C) a higher interest rate.
D) first a lower and then a higher interest rate.

88. According to the theory of liquidity preference, holding the supply of real money
balances constant, an increase in income will ______ the demand for real money
balances and will ______ the interest rate.
A) increase; increase
B) increase; decrease
C) decrease; decrease

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D) decrease; increase

89. If money demand does not depend on income, then the ______ curve is ______.
A) IS; vertical
B) IS; horizontal
C) LM; vertical
D) LM; horizontal

90. If money demand is extremely sensitive to the interest rate, then the ______ curve is
______.
A) IS; vertical
B) IS; horizontal
C) LM; vertical
D) LM; horizontal

91. The LM curve, in the usual case:

A) is vertical.
B) is horizontal.
C) slopes down to the right.
D) slopes up to the right.

92. An explanation for the slope of the LM curve is that as:

A) the interest rate increases, income becomes higher.
B) the interest rate increases, income becomes lower.
C) income rises, money demand rises, and a higher interest rate is required.
D) income rises, money demand rises, and a lower interest rate is required.

93. The LM curve is steeper the ______ the interest sensitivity of money demand and the
______ the effect of income on money demand.
A) greater; greater
B) greater; smaller
C) smaller; smaller
D) smaller; greater

94. If the demand function for money is M/P = 0.5Y ñ 100r, then the slope of the LM curve
is:
A) 0.001.
B) 0.005.
C) 0.01.
D) 0.05.

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 95. If money demand does not depend on the interest rate, then the LM curve is ______ and
______ policy has no effect on output.
A) horizontal; fiscal
B) vertical; fiscal
C) horizontal; monetary
D) vertical; monetary

96. If the demand function for money is M/P = 0.5Y ñ 100r and if M/P increases by 100,
then the LM curve for any given interest rate shifts to the:
A) left by 100.
B) left by 200.
C) right by 100.
D) right by 200.

97. An LM curve shows combinations of:

A) taxes and government spending.
B) nominal money balances and price levels.
C) interest rates and income, which bring equilibrium in the market for real money
balances.
D) interest rates and income, which bring equilibrium in the market for goods and
services.

98. A decrease in the real money supply, other things being equal, will shift the LM curve:
A) downward and to the left.
B) upward and to the left.
C) downward and to the right.
D) upward and to the right.

99. A decrease in the nominal money supply, other things being equal, will shift the LM
curve:
A) upward and to the right.
B) downward and to the right.
C) downward and to the left.
D) upward and to the left.

100. A decrease in the price level, holding nominal money supply constant, will shift the LM
curve:
A) upward and to the right.
B) downward and to the right.

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C) downward and to the left.
D) upward and to the left.

101. An increase in income raises money ______ and ______ the equilibrium interest rate.
A) demand; raises
B) demand; lowers
C) supply; raises
D) supply; lowers

103. At a given interest rate, an increase in the nominal money supply ______ the level of
income that is consistent with equilibrium in the market for real balances.
A) raises
B) lowers
C) does not change
D) may either raise or lower

104. Changes in monetary policy shift the:

A) LM curve.
B) planned spending curve.
C) money demand curve.
D) IS curve.

105. The LM curve shows combinations of ______ that are consistent with equilibrium in the
market for real money balances:
A) inflation and unemployment
B) the price level and real output
C) the interest rate and the level of income
D) the interest rate and real money balances

106. If the quantity theory of money is valid, then the LM curve:

A) slopes upward and to the right.
B) slopes downward and to the right.
C) is vertical.
D) is horizontal.

107. The assumption of constant velocity is equivalent to assuming that the demand for real
money balances depends on:
A) income alone.
B) the interest rate alone.

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C) income and interest rates.
D) people economizing on real balances as the interest rate rises.

108. According to the theory of liquidity preference, velocity is:

A) positively related to the interest rate.
B) negatively related to the interest rate.
C) independent of the interest rate.
D) equal to one divided by the interest rate.

109. For any given interest rate and price level, an increase in the money supply:
A) lowers income.
B) raises income.
C) has no effect on income.
D) lowers velocity.

110. According to the quantity equation, if velocity is not assumed to be constant and the
money supply is held constant, then an increase in the interest rate ______ velocity and
______ income.
A) increases; increases
B) increases; decreases
C) decreases; decreases
D) decreases; increases

111. According to the theory of liquidity preference, a decrease in income will ______
interest rates, and according to the quantity equation (assuming velocity is not constant),
a decrease in interest rates will ______ income.
A) increase; increase
B) increase; decrease
C) decrease; decrease
D) decrease; increase

112. The LM curve generally determines:

A) income.
B) the interest rate.
C) both income and the interest rate.
D) neither income nor the interest rate.

113. The IS and LM curves together generally determine:

A) income only.
B) the interest rate only.

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C) both income and the interest rate.
D) income, the interest rate, and the price level.

114. The interest rate is a determinant of ______ in the goods market and money ______ in
the money market.
A) government spending; demand
B) government spending; supply
C) investment spending; demand
D) investment spending; supply

115. The intersection of the IS and LM curves determines the values of:
A) r, Y, and P, given G, T, and M.
B) r, Y, and M, given G, T, and P.
C) r and Y, given G, T, M, and P.
D) p and Y, given G, T, and M.

116. Equilibrium levels of income and interest rates are ______ related in the goods and
services market, and equilibrium levels of income and interest rates are ______ related
in the market for real money balances.
A) positively; positively
B) positively; negatively
C) negatively; negatively
D) negatively; positively

118. The IS curve provides combinations of interest rates and income that satisfy equilibrium
in the market for ______, and the LM curve provides combinations of interest rates and
income that satisfy equilibrium in the market for ______.
A) saving and investment; planned spending
B) real-money balances; loanable funds
C) goods and services; real-money balances
D) real-money balances; goods and services

119. If consumption is given by C = 200 + 0.75(Y ñ T) and investment is given by I = 200 ñ

25r, then the formula for the IS curve is:
A) Y = 400 ñ 0.75T ñ 25r + G.
B) Y = 1,600 ñ 3T ñ 100r + 4G.
C) Y = 400 + 0.75T ñ 25r ñ G.
D) Y = 1,600 + 3T ñ 100r ñ 4G.

120. If the IS curve is given by Y = 1,700 ñ 100r and the LM curve is given by Y = 500 +

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 100r, then equilibrium income and interest rate are given by:
A) Y = 1,100, r = 6 percent.
B) Y = 1,200, r = 5 percent.
C) Y = 1,000, r = 5 percent.
D) Y = 1,100, r = 5 percent.

121. If the IS curve is given by Y = 1,700 ñ 100r, the money demand function is given by
(M/P)d = Y ñ 100r, the money supply is 1,000, and the price level is 2, then if the money
supply is raised to 1,200, equilibrium income rises by:
A) 200 and the interest rate falls by 2 percent.
B) 100 and the interest rate falls by 1 percent.
C) 50 and the interest rate falls by 0.5 percent.
D) 200 and the interest rate remains unchanged.

122. According to the Keynesian-cross analysis, if the marginal propensity to consume is 0.6,
and government expenditures and autonomous taxes are both increased by 100,
equilibrium income will rise by:
A) 0.
B) 100.
C) 150.
D) 250.

123. In the Keynesian-cross analysis, if the consumption function is given by C = 100 +

0.6(Y ñ T), and planned investment is 100, G is 100, and T is 100, then equilibrium Y is:
Y=c+I+G = Y = 100 + 0.6(Y - T) + 100 + 100
=300+0.6(y-100)

A) 350.
B) 400.
C) 600.
D) 750.

124. Using the Keynesian-cross analysis, assume that the consumption function is given by C
= 100 + 0.6(Y ñ T). If planned investment is 100 and T is 100, then the level of G needed
to make equilibrium Y equal 1,000 is:
A) 200.
B) 240.
C) 250.
D) 260.

125. In the Keynesian-cross model, assume that the analysis of taxes is changed so that taxes,

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 T, are made a function of income, as in T = T + tY, where T and t are parameters of the
tax code and t is positive but less than 1. As compared to a case where t is zero, the
multiplier for government purchases in this case will:
A) not change.
B) be smaller.
C) be bigger.
D) be equal to 1.

126. Consider the impact of an increase in thriftiness in the Keynesian-cross analysis.

Assume that the marginal propensity to consume is unchanged, but the intercept of the
consumption function is made smaller so that at every income level saving is greater.
This will:
A) lower equilibrium income by the decrease in the intercept multiplied by the
multiplier.
B) lower equilibrium income by the decrease in the intercept.
C) raise equilibrium income by the decrease in the intercept.
D) raise equilibrium income by the decrease in the intercept multiplied by the
multiplier.

127. Consider the impact of an increase in thriftiness in the Keynesian-cross analysis.

Assume that the marginal propensity to consume is unchanged, but the intercept of the
consumption function is made smaller so that at every income level saving is greater.
This will:
A) increase saving by the decrease in the intercept.
B) lead to no change in saving.
C) decrease saving by the decrease in the intercept.
D) lead to an increase in investment.

128. Assume that the money demand function is (M/P)d = 2,200 ñ 200r, where r is the
interest rate in percent. The money supply M is 2,000 and the price level P is 2. The
equilibrium interest rate is ______ percent.
M2000/2 = 1000 2200-200x=1000

A) 2
B) 4
C) 6
D) 8

129. Assume that the money demand function is (M/P)d = 2,200 ñ 200r, where r is the
interest rate in percent. The money supply M is 2,000 and the price level P is 2. If the
price level is fixed and the supply of money is raised to 2,800, then the equilibrium
interest rate will:

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 A) drop by 4 percent.
B) drop by 2 percent.
C) drop by 1 percent.
D) remain unchanged.

130. Assume that the money demand function is (M/P)d = 2,200 ñ 200r, where r is the
interest rate in percent. The money supply M is 2,000 and the price level P is 2. If the
price level is fixed and the Bank of Canada wants to fix the interest rate at 7 percent, it
should set the money supply at:
A) 2,000.
B) 1,800.
C) 1,600.
D) 1,400.
2200-(200x7)=800 x 2 = 1600

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Answer Key

1. D
2. B
3. B
4. B
5. D
6. A
7. A
8. D
9. A
10. C
11. D
12. B
13. A
14. C
15. B
16. B
17. C
18. C
19. B
20. C
21. B
22. C
23. A
24. C
25. A
26. B
27. B
28. C
29. D
30. B
31. C
32. A
33. B
34. C
35. D
36. C
37. C
38. C
39. C
40. C
41. A
42. A
43. D
44. A

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45. D
46. D
47. A
48. B
49. A
50. D
51. C
52. C
53. B
54. D
55. B
56. A
57. B
58. D
59. D
60. A
61. A
62. D
63. C
64. D
65. C
66. D
67. D
68. A
69. B
70. B
71. B
72. D
73. A
74. A
75. B
76. B
77. A
78. B
79. D
80. A
81. A
82. C
83. B
84. C
85. B
86. D
87. C
88. A
89. D
90. D

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 91. D
92. C
93. D
94. B
95. B
96. D
97. C
98. B
99. D
100. B
101. A
102. A
103. A
104. A
105. C
106. C
107. A
108. A
109. B
110. A
111. C
112. D
113. C
114. C
115. C
116. D
117. A
118. C
119. B
120. A
121. C
122. B
123. C
124. D
125. B
126. A
127. B
128. C
129. B
130. C
131. a. Planned spending is 1,600. Inventory decumulation is 100. Equilibrium Y
should be higher than 1,500.
b. Equilibrium Y is 1,800.
c. Consumption is 1,200, private saving is 300, public saving is 0, and
national saving is 300.
d. Equilibrium Y decreases by 300. The multiplier is 3.

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132. a. Y = 2,800 ñ 400r or r = 7 ñ 0.0025Y.
b. The slope of the IS curve is ñ0.0025.
c. If r is 1 percent, I is 800 and Y is 2,400. If r is 3 percent, I is 400 and Y is
1,600. If r is 5 percent, I is 0 and Y is 800.
d. IS shifts upward and to the right.
133. a. Y = 1,600 + 200r, or r = ñ8 + 0.005Y.
b. The slope of the LM curve is 0.005.
c. If r is 1 percent, Y is 1,800. If r is 3 percent, Y is 2,200. If r is 5 percent, Y
is 2,600.
d. The LM curve shifts downward and to the right.
e. The LM curve shifts downward and to the right.
f. The LM curve shifts upward and to the left.
134. a.

b. The equilibrium level of income falls. This analysis is appropriate in the short run
when prices and the interest rate are constant.
135. a.

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 b. The equilibrium level of income increases. This analysis is appropriate in the short
run when prices and the interest rate are constant.
136. a.

b. The equilibrium level of income falls.

137. a.

Page 28
 b. The equilibrium interest rate falls.
138. a.

b. The equilibrium interest rate falls.

139. a. Tax cuts do not change the money supply, which is controlled by the
central bank. Changes in the money supply shift the LM curve.
b. Tax cuts shift the IS curve.
c. The President used the word ìmoneyî as it is popularly understood, but not
according to its macroeconomic meaning. Rephrasing the statement to say
ìwhen people have more disposable income as a result of the tax cut, they
can spend more on goods and servicesî would make the statement
consistent with the economic model.
140. In the market for goods and services if planned spending exceeds actual spending, for
example, then inventories will become depleted, firms will increase production, hire
more workers, and increase income and output until equilibrium is achieved. In the
market for real money balances, if the supply of real money balances exceeds the
demand, for example, households will buy bonds, driving bond prices up and interest
rates down. Interest rates will continue to decline until households are eventually willing
to hold the amount of real-money balances supplied.
141. Income in Country A will increase more. The government-spending multiplier in
Country A equals 10, so income in Country A will increase by $20 billion. The tax
multiplier in Country B equals 9, so income in Country B will only increase by $18
billion.
142. a. The interest rate affects investment in the market for goods and services,
and the demand for money in the market for real money balances.
b. The level of income affects consumption in the market for goods and
services, and the demand for money in the market for real money balances.
143. The liquidity preference model predicts that an increase in the money supply will
decrease interest rates. The quantity theory predicts that an increase in the money supply
will increase inflation, which, via the Fisher effect, will increase the nominal interest
rate. The liquidity preference model emphasizes the short-run effect when prices are
fixed, while the quantity theory and Fisher effect are long-run effects when prices are
flexible.
144. a. The ISñLM model simultaneously determines equilibrium in the goods market and the
money market.
b. The interest rate (r) and real output (Y) are the two variables that adjust to bring
equilibrium in both markets.

Page 29
145. A decrease in planned investment spending decreases planned spending, which will
reduce the equilibrium level of income in the goods market. A decrease in income
decreases the demand for real money balances in the money market, which will decrease
the equilibrium level of the interest rate in the money market. Graphically, this is
represented by a shift in the IS curve to the left and a movement down the LM curve.
146. An increase in the money supply will decrease the equilibrium interest rate in the money
market. A lower interest rate will increase investment spending in the goods market,
which will increase the equilibrium level of income in the goods market. Graphically,
this is represented by a shift in the LM curve to the right and a movement down the IS
curve.
147. A decrease in exogenous consumption reduces planned spending, which reduces the
equilibrium level of income by a greater amount via the consumption spending
multiplier, i.e., a decrease in consumption spending leads to a decrease in income, which
leads to another decrease in consumption spending, and so on. At the new lower
equilibrium level of income, both income and consumption spending will have
decreased by the same amount, so that national saving (Y ñ C ñ G) will be unchanged.
148. a.

b. The equilibrium levels of saving and investment increase. The interest

rate falls.

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