ECS2602 ASS 2 Semester 2 2023. LEARNING UNITS 4, 5 and 6.

1. Which of the following can be regarded as the fully exogenous variables in the IS-LM model? a. Nominal money supply. b. Taxes. c. Investment spending. d. Government spending. 1. a, b, c and d 2. b, c and d 3. a, c and d 4. Only b and d 5. Only a, b and d Explanation: The three critical exogenous – i.e. external – variables in the IS-LM model are liquidity, investment, and consumption. According to the theory, liquidity is determined by the size and velocity of the money supply. The levels of investing and consumption are determined by the marginal decisions of individual actors. 2. Which of the following statements is/are correct? In the IS-LM model: a. Investment is influenced by the interest rate only. b. Investment is influenced by exogenous factors such as expectations, business confidence and regulations. c. Investment is influenced by the interest rate and the level of output. d. Investment is negatively related to the interest rate and the level of output. e. Investment is negatively related to the interest rate and positively related to the level of output. 1. a and b 2. b, c and e 3. b, c and d 4. a and e 5. Only c and e 3. Which of the following statements is/are correct? a. The positive relationship between the level of output and investment spending is represented by Y↑ → I↓. b. An increase in the interest rate decreases investment spending which decreases the demand for goods and the equilibrium level of income falls. c. An increase in investors’ confidence increases investment spending. d. When deriving the IS curve the following chain of events describes what happens on the goods market if the interest rate decreases: i↓ → I↑ → T↓ → YD↑ → Z↑ → Y↑. 1. Only a and b 2. Only b and c 3. b, c and d 4. a, b and c 5. Only c Explanation: There is positive relationship between investment and output, but however the causality runs from investment to output since investment is regarded as exogenously determined. An increase in the interest rate decreases investment spending which decreases the demand for goods [Since investment is a component of national output] and the equilibrium level of income falls. 11. When deriving the LM curve which one of the following chain of events describes the impact of a decrease in output on the financial market? 1. i↓ → I↑ → Z↑ → Y↑ 2. Y↓ → Md↓ → i↑ 3. Y↓ → Md↑ → i↓ 4. Y↓ → Md↓ → i↓ 5. Y↓ → Ms↓ → i↑ 12. The statement that the LM curve is upward sloping since an increase in the interest rate increases the demand for money is incorrect because it is … 1. upward sloping since an increase in the interest rate decreases the demand for money. 2. upward sloping since an increase in the interest rate increases the money supply. 3. Upward sloping since an increase in income increases the demand for money and the interest rate. 4. upward sloping since an increase in the interest rate increases the income level. 5. Upward sloping since an increase in income increases the money supply. Explanation: The LM curve is upward sloping because higher income results in higher demand for money, thus resulting in higher interest rates.