C216 Lecture 7 - The Closed Economy IS-LM Model Exam Questions with Correct Answers Latest Update

C216 Lecture 7 - The Closed Economy IS-LM Model Exam Questions with Correct Answers Latest Update What does the IS Curve represent in the IS-LM model? - Answers The IS Curve represents the set of all combinations of output (Y) and interest rate (i) for which the goods market is in equilibrium. What does the LM Curve represent in the IS-LM model? - Answers The LM Curve represents the set of all combinations of output (Y) and interest rate (i) for which the financial market is in equilibrium. What is the primary assumption about output in the Short Run of the IS-LM model? - Answers Output is determined by demand, with fixed prices except for the interest rate. How does an increase in the interest rate affect the IS Curve? - Answers An increase in the interest rate leads to a decrease in investment, causing a fall in demand and a new equilibrium at a lower output level. What is the relationship between interest rates and output on the IS Curve? - Answers The IS Curve is downward sloping, indicating that higher interest rates lead to lower output. What is the equilibrium condition in the goods market? - Answers Equilibrium occurs when demand (Z) equals income (Y). What is the function of money demand in the LM model? - Answers Money demand is a function of income (Y) and the interest rate (i), where money demand decreases as the interest rate increases. What is the effect of a constant money supply (M) on the LM Curve? - Answers A constant money supply implies an upward sloping LM Curve. What happens to the equilibrium output and interest rate when the IS and LM curves intersect? - Answers At the intersection, both the goods market and money market are in equilibrium, determining the equilibrium output (Y*) and interest rate (i*). What is contractionary fiscal policy? - Answers Contractionary fiscal policy involves decreasing government spending or increasing taxes to reduce the budget deficit. What is expansionary fiscal policy? - Answers Expansionary fiscal policy involves increasing government spending or decreasing taxes to increase the budget deficit. What is the impact of an increase in taxes on consumption expenditures? - Answers An increase in taxes leads to a decrease in consumption expenditures, which lowers income and output. What is a Balanced Budget Fiscal Expansion? - Answers A Balanced Budget Fiscal Expansion occurs when government spending increases while taxes also increase, leading to a net increase in output. What is contractionary monetary policy? - Answers Contractionary monetary policy involves decreasing the money supply and increasing interest rates. What is expansionary monetary policy? - Answers Expansionary monetary policy involves increasing the money supply and decreasing interest rates. What is the Zero Lower Bound on interest rates? - Answers The Zero Lower Bound is the situation where interest rates approach zero, making monetary policy ineffective at stimulating the economy. What occurs in a liquidity trap? - Answers In a liquidity trap, further increases in the money supply do not lower interest rates or boost output.