EMA 3672 INTERMEDIATE MACRO ECONOMICS

ASSIGNMENT/ TEST: IS-LM AND LABOUR MAREKT

SUBMISSION DATE: 7 SEPTEMBER 2021
Total: 120 marks

SECTION A: MULTIPLE CHOICE QUESTIONS (20 marks)

1. Suppose the current level of output and the interest rate are such that the economy is
operating on neither the IS nor LM curve. Which of the following is true for this economy
A. Production does not equal demand.
B. The money supply does not equal money demand.
C. Financial markets are not in equilibrium.
D. all of the above.

2. Which of the following is the definition for the real supply of money?
A. the stock of money measured in terms of goods, not dollars.
B. the stock of high powered money only.
C. the actual quantity of money, rather than the officially reported quantity.
D. the ratio of the real GDP to the nominal money supply.

3. Points on the IS curve satisfy

A. money market equilibrium.
B. goods market equilibrium.
C. stock market equilibrium.
D. none of the above.

4. 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.

5. A decrease in wealth would cause the IS curve to

A. shift up and to the right.
B. shift down and to the left.
C. remain unchanged.
D. shift up and to the right only if people face borrowing constraints.

6. Which of the following occurs as the economy moves leftward along a given IS curve?
A. an increase in the interest rate causes investment spending to decrease
B. an increase in the interest rate causes money demand to increase
C. an increase in the interest rate causes a reduction in the money supply
D. a reduction in government spending causes a reduction in demand for goods
7. Suppose investment spending is NOT very sensitive to the interest rate. Given this
information, we know that
A. the IS curve should be relatively flat.
B. the IS curve should be relatively steep.
C. the LM curve should be relatively flat.
D. the LM curve should be relatively steep.

8. Suppose the demand for money is NOT very sensitive to the interest rate. Given this
information, we know that
A. the IS curve should be relatively flat.
B. the IS curve should be relatively steep.
C. the LM curve should be relatively flat.
D. the LM curve should be relatively steep.

9. An increase in the money supply must cause which of the following?

A. a leftward shift in the IS curve
B. a reduction in the interest rate and ambiguous effects on investment
C. an increase in investment and a rightward shift in the IS curve
D. no change in output if investment is independent of the interest rate

10.. In the Keynesian model the quantity of money demanded is _____ related to income and
_____related to the interest rate.
A. positively; positively
B. positively; negatively
C. negatively; negatively
D. negatively; positively

11. If the demand for real money balances does not depend on the interest rate, then the LM
curve:
A. slopes up to the right.
B. slopes down to the right.
C. is horizontal.
D. is vertical.

12. If people suddenly wish to hold more money at all levels of the rate of interest,
A.t he money supply curve will shift to the right.
B. the equilibrium rate of interest will fall.
C. the LM curve will shift down to the right.
D. the IS curve will shift down to the left.

13. Consider a closed economy with a fixed-price level. If investment is very sensitive to the
interest rate, which one of the following statements would be correct?
A. The LM curve will be steep.
B. The IS curve will be steep.
C. Monetary policy will have a large effect on nominal interest rates.
D. Monetary policy will have a large effect on output.
14. Suppose the demand for money is NOT very sensitive to the interest rate. Given this
information, we know that
A. the IS curve should be relatively flat.
B. the IS curve should be relatively steep.
C. the LM curve should be relatively flat.
D. the LM curve should be relatively steep.

15. An increase in the money supply must cause which of the following?
A. a leftward shift in the IS curve
B. a reduction in the interest rate and ambiguous effects on investment
C. an increase in investment and a rightward shift in the IS curve
D. no change in output if investment is independent of the interest rate

16. The reservation wage is

A) the wage that an employer must pay workers to reduce turnover to a reasonable level.
B) the wage that ensures a laid-off individual will wait for re-hire, rather than find another
job.
C) the lowest wage firms are allowed by law to pay workers
D) the wage offer that will end a labor-strike.
E) none of the above

17. In the wage-setting relation, the nominal wage tends to decrease when
A) the price level increases.
B) the unemployment rate decreases.
C) unemployment benefits decrease.
D) the minimum wage increases.
E) all of the above

18. In the wage setting relation W = PeF(u,z), the variable z does NOT include which of the
following variables?
A) the minimum wage
B) unemployment benefits
C) the extent to which firms mark up prices over their marginal cost
D) all of the above
E) none of the above

19. The price setting equation is represented by the following: P = (1+m)W. When there is
perfect competition, we know that m will equal
A) W.
B) P.
C) 1.
D) W/P.
E) none of the above
20. The natural rate of unemployment is the rate of unemployment
A) that occurs when the money market is in equilibrium.
B) that occurs when the markup of prices over costs is zero.
C) where the markup of prices over costs is equal to its historical value
D) that occurs when both the goods and financial markets are in equilibrium.
E) none of the above

SECTION B: LONGER QUESTIONS: IS-LM MODEL (50 marks)

Use the IS-LM model to answer this question. Suppose there is a simultaneous increase in
government spending and reduction in the money supply.
1.1. Explain what effect this particular policy mix will have on output and the interest rate
(4)
1.2. Based on your analysis, do we know with certainty what effect this policy mix will have
on investment? Explain. (4)

2. Explain why each of the following statements is true. Discuss the impact of monetary and
fiscal policy in each of these special cases:
2. 1. If investment does not depend on the interest rate, the IS curve is vertical. (4)
2..2. If money demand does not depend on the interest rate, the LM curve is vertical. (4)

3. We normally draw the IS curve as downward sloping and the LM curve as upward sloping,
as appropriate for our usual assumptions about behavior. How would either or both of these
curves look different if the following unusual assumptions were made? Motivate your answer
clearly
3.1. The MPC is one. (4)
l3.2. Demand for money does not depend on income. (4)

4.For an economy the following functions have been given:

C = 100 + 0.8Y S = -100 + 0.2Y
I = 120 – 5r Ms = 120 Md = 0.2Y – 5r
Find out
4.1.IS equation (4)
4.2. LM equation (4)
4.3. equilibrium level of income and interest rate. (4)

5. For each of the following, draw into the diagram provided how the curve or curves should
shift in the IS-LM model of a closed economy with fixed prices, and explain in a sentence or
two the reason(s) for the shift(s).
5.1. An increase in government purchases financed by borrowing. (4) :
5.2. An increase in government purchases financed by increasing taxes by the same amount.
(4)
6. Using appropriate diagrams compare the effectiveness of fiscal policy in
6.1.the liquidity trap; (3 marks)
6..2. the Classical range. (3 marks)

SECTION C: LONGER QUESTIONS: LABOUR MARKET (50 marks)

1.Use the WS (wage-setting) and PS (price-setting) relations to examine the effects of the
following events on the natural rate of unemployment and on the real wage. Be sure to
explain the effects of each event on the WS and PS relations and draw a graph.
1.1.A reduction in unemployment benefits. (6)
1.2. Less stringent anti-trust enforcement (leading to less competitive markets) (6)

2. Answer the following questions with regard to the impact of competitive conditions and
the markup on the real wage (W/P)
.2.1. Calculate the real wage (W/P) if the value of the markup, μ = 0.1. (2 marks)
.2.2. Explain why the real wage changes as the markup μ increases. (2 marks)
2.3. Suppose that all markets are perfectly competitive. What is the value of the markup, μ
when perfect competition exists? (2 marks)
2.4. Explain what the real wage paid by firms will be when all markets are perfectly
competitive? 2 marks)

3. Provide a brief explanation of what the unemployment rate measures and explain
how changes in each of the components of the unemployment rate can cause changes in the
unemployment rate. (6)

4. Explain several implications and characteristics of efficiency wage theories. (3)

5. Explain how an increase in the unemployment rate will affect bargaining power and
nominal wages. (3)

6. Explain what effect a reduction in the unemployment rate will have on the real wage based
on: (1) the WS relation; and (2) the PS relation. (4)

7. Explain what the WS relation represents and explain why it has its particular shape. (4)

8. Explain what the PS relation represents and explain why it has its particular shape. (4)

9. The following was reported by ECNA on 29 September 2020: “Despite the loss of 2.2
million jobs in the second quarter of the year, the labour force survey released by Stats SA
indicates there was also a massive decline in unemployment. The official unemployment rate
decreased from 30.1% in the first quarter of 2020 to a record low of 23.3% in the data from
April to June this year. The country was under a hard lockdown in the second quarter of the
year.”

9.1. Explain how it is possible that the unemployment rate has decreased, while there was a
loss of 2.2 million jobs. In your answer, make sure that you refer to the definition of
unemployment. (2)
9.2. Do you think that the “official” unemployment rate mentioned here provide a misleading
indication of the unemployment rate in the current circumstances? Is there an alternative
definition of employment that can provide a better indication of the unemployment rate in the
current situation? (2)

10. Explain why nominal wages are a function of the expected price level (2)