PART I

1. A variable that links the market for goods and services and the market for real money
balances in the IS–LM model is the:

A) consumption function.
B) interest rate.
C) price level.
D) nominal money supply.

2. In the IS–LM 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 money balances and government purchases
C) supply of nominal money balances and investment spending
D) demand for real money balances and investment spending

3. 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

4. For the purposes of the Keynesian cross, 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.

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

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

6. 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.

7. 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.

8. In the Keynesian-cross model, if the MPC equals 0.75, then a $1 billion increase in
government spending increases planned expenditures by ______ and increases the
equilibrium level of income by ______.

A) $1 billion; more than $1 billion

B) $0.75 billion; more than $0.75 billion
C) $0.75 billion; $0.75 billion
D) $1 billion; $1 billion

9. 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

10. 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

11. 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

12. The IS curve shifts when any of the following economic variables change except:

A) the interest rate.

B) government spending.
C) tax rates.
D) the marginal propensity to consume.

13. 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.

14. 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.

15. Changes in fiscal policy shift the:

A) LM curve.
B) money demand curve.
C) money supply curve.
D) IS curve.

16. 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.

17. 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.

18. 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.

19. 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.

20. 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.

21. 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.

22. 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.

23. 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.

24. 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.

25. Changes in monetary policy shift the:

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

26. 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

27. Using the Keynesian-cross analysis, assume that the consumption function is given
by C = 100 + 0.6(Y – 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.
 28. Assume that the money demand function is (M/P)d = 2,200 – 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.

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

29. Assume that the consumption function is given by C = 200 + 0.5(Y – T) and the
investment function is I = 1,000 – 200r, where r is measured in percent, G equals
300, and T equals 200.
a. What is the numerical formula for the IS curve? (Hint: Substitute for C, I, and G
equation Y = C + I + G and then write an equation for Y as a function of r or r as a function
of Y.) Express the equation two ways.

b. What is the slope of the IS curve? (Hint: The slope of the IS curve is the coefficient of
when the IS curve is written expressing r as a function of Y.)
c. If r is one percent, what is I? What is Y? If r is 3 percent, what is I? What is Y? If
percent, what is I? What is Y?
d. If G increases, does the IS curve shift upward and to the right or downward and to the left?

30. Assume that the equilibrium in the money market may be described as M/P = 0.5Y
– 100r, and M/P equals 800.
a. Write the LM curve two ways, expressing Y as a function of r and r as a function of
Write the LM curve only relating Y and r; substitute out M/P.)
b. What is the slope of the LM curve?
c. If r is 1 percent, what is Y along the LM curve? If r is 3 percent, what is Y along the
curve? If r is 5 percent, what is Y along the LM curve?
d. If M/P increases, does the LM curve shift upward and to the left or downward and to the
right?
e. If M increases and P is constant, does the LM curve shift upward and to the left or downw
and to the right?
f. If P increases and M is constant, does the LM curve shift upward and to the left or downw
and to the right?

31. Explain why a decrease in planned investment, which is a change in the goods market,
will upset the equilibrium in the money market.

32. Explain why an increase in the money supply, which is a change in the money market,
will upset the equilibrium in the goods market.
 33. a. Suppose Congress passes legislation that significantly reduces taxes. Use the
Keynesian-cross model to illustrate graphically the impact of a reduction in taxes
on the equilibrium level of income. Be sure to label: i. the axes; ii. the curves; iii.
the initial equilibrium values; iv. the direction the curve shifts; and v. the terminal
equilibrium values.
b. Explain in words what happens to equilibrium income as a result of the tax cut and
the time horizon appropriate for this analysis.

PART II
1. The interaction of the IS curve and the LM curve together determine:
A) the price level and the inflation rate.
B) the interest rate and the price level.
C) investment and the money supply.
D) the interest rate and the level of output.

2. In the IS–LM model when government spending rises, in short-run equilibrium, in the
usual case the interest rate ______ and output ______.
A) rises; falls
B) rises; rises
C) falls; rises
D) falls; falls

3. In the IS–LM model, the impact of an increase in government purchases in the goods
market has ramifications in the money market, because the increase in income causes
a(n) ______ in money ______.
A) increase; supply
B) increase; demand
C) decrease; supply
D) decrease; demand

4. If the LM curve is vertical and government spending rises by G, in the IS–LM analysis,
then equilibrium income rises by:
A) G/(1 – MPC).
B) more than zero but less than G/(1 – MPC).
C) G.
D) zero.

5. If MPC = 0.75 (and there are no income taxes) when G increases by 100, then the IS
curve for any given interest rate shifts to the right by:
A) 100.
B) 200.
C) 300.
D) 400.
 6. In the IS–LM model under the usual conditions in a closed economy, an increase in
government spending increases the interest rate and crowds out:
A) prices.
B) investment.
C) the money supply.
D) taxes.

7. Using the IS–LM analysis, if the LM curve is not horizontal, the multiplier for an
increase in government spending is ______ for an increase in government purchases
using the Keynesian-cross analysis.
A) larger than the multiplier
B) the same as the multiplier
C) smaller than the multiplier
D) sometimes larger and sometimes smaller than the multiplier

8. If the money supply increases, then in the IS–LM analysis the ______ curve shifts to the
______.
A) LM; left
B) LM; right
C) IS; left
D) IS; right

9. In the IS–LM model when M/P rises, in short-run equilibrium, in the usual case the
interest rate ______ and output ______.
A) rises; falls
B) rises; rises
C) falls; rises
D) falls; falls

10. In the IS–LM model when the Federal Reserve decreases the money supply, people
______ bonds and the interest rate ______, leading to a(n) ______ in investment and
income.
A) buy; rises; increase
B) sell; falls; decrease
C) sell; rises; decrease
D) buy; rises; decrease

11. The monetary transmission mechanism in the IS–LM model is a process whereby an
increase in the money supply increases the demand for goods and services:
A) directly.
B) by lowering the interest rate so that investment spending increases.
C) by raising the interest rate so that investment spending increases.
D) by increasing government spending on goods and services.
 12. According to the IS–LM model, if Congress raises taxes but the Fed wants to hold the
interest rate constant, then the Fed must ______ the money supply.
A) increase
B) decrease
C) first increase and then decrease
D) first decrease and then increase

13. If taxes are raised, but the Fed prevents income from falling by raising the money
supply, then:
A) both consumption and investment remain unchanged.
B) consumption rises but investment falls.
C) investment rises but consumption falls.
D) both consumption and investment fall.

Use the following to answer questions 14-16:

Exhibit: Policy Interaction

14. (Exhibit: Policy Interaction) Based on the graph, starting from equilibrium at interest
rate r3, income Y2, IS1, and LM1, if there is an increase in government spending that
shifts the IS curve to IS2, then in order to keep the interest rate constant, the Federal
Reserve should _____ the money supply shifting to _____.
A) increase; LM2
B) decrease; LM2
C) increase; LM3
D) decrease; LM3

15. (Exhibit: Policy Interaction) Based on the graph, starting from equilibrium at interest
rate r3, income Y2, IS1, and LM1, if there is an increase in government spending that
shifts the IS curve to IS2, then in order to keep output constant, the Federal Reserve
should _____ the money supply shifting to _____.
A) increase; LM2
B) decrease; LM2
C) increase; LM3
D) decrease; LM3
16. (Exhibit: Policy Interaction) Based on the graph, starting from equilibrium at interest
rate r3, income Y2, IS1, and LM1, if there is an increase in government spending that
shifts the IS curve to IS2 and the Federal Reserve does not change the money supply, the
new equilibrium combination of interest and income will be _____.
A) r1, Y2
B) r2, Y3
C) r3, Y3
D) r3, Y4

17. According to the macroeconometric model developed by Data Resources Incorporated,

the response of GDP four quarters after an increase in government spending, with the
nominal interest rate held constant, will be ______ the response of GDP to a similar
change with the money supply held constant.
A) less than half as great as
B) approximately equal to
C) more than two times as great as
D) more than three times as great as

18. An increase in consumer saving for any given level of income will shift the:
A) LM curve upward and to the left.
B) LM curve downward and to the right.
C) IS curve downward and to the left.
D) IS curve upward and to the right.

19. In the IS–LM model, a decrease in output would be the result of a(n):
A) decrease in taxes.
B) increase in the money supply.
C) increase in money demand.
D) increase in government purchases.

20. One policy response to the U.S. economic slowdown of 2001 was tax cuts. This policy
response can be represented in the IS–LM model by shifting the ______ curve to the
______.
A) LM; right
B) LM; left
C) IS; right
D) IS; left

21. When bond traders for the Federal Reserve seek to increase interest rates, they ______
bonds, which shifts the ______ curve to the left.
A) buy; IS
B) buy; LM
C) sell; IS
D) sell; LM
22. The aggregate demand curve generally slopes downward and to the right because, for
any given money supply M a higher price level P causes a ______ real money supply
M/P, which ______ the interest rate and ______ spending.
A) lower; raises; reduces
B) higher; lowers; increases
C) lower; lowers; increases
D) higher; raises; reduces

23. A change in income in the IS–LM model for a fixed price

A) represents a shift in the aggregate demand curve.
B) represents a movement along the aggregate demand curve.
C) has the same effect on the aggregate demand curve as a change in income in the
IS–LM model resulting from a change in the price level.
D) does not represent a change in the aggregate demand curve.

24. A tax cut shifts the ______ to the right, and the aggregate demand curve ______.
A) IS; shifts to the right
B) IS; does not shift
C) LM: shifts to the right
D) LM; does not shift

25. A decrease in the price level shifts the ______ curve to the right, and the aggregate
demand curve ______.
A) IS; shifts to the right
B) IS; does not shift
C) LM: shifts to the right
D) LM; does not shift (IS= investment / savings curve not affected by price level)

26. A change in income in the IS–LM model resulting from a change in the price level is
represented by a ______ aggregate demand curve, while a change in income in the IS–
LM model for a given price level is represented by a ______ aggregate demand curve.
A) movement along the; shift in the
( IS-LM model )
price level= movement
Income change = shift

B) shift in the; movement along the

C) vertical; horizontal
D) horizontal; vertical

27. Starting from a short-run equilibrium greater than the natural rate of output, as the
economy returns to a long-run equilibrium:
A) both output and the price level will increase.
B) output will decrease, but the price level will increase.
C) output will increase, but the price level will decrease.
D) both output and the price level will decrease.
 28. If the short-run IS–LM equilibrium occurs at a level of income below the natural level of
output, then in the long run the price level will ______, shifting the ______ curve to the
right and returning output to the natural level.
A) increase; IS
B) decrease; IS
C) increase; LM
D) decrease; LM

29. If the short-run IS–LM equilibrium occurs at a level of income above the natural level of
output, in the long run the ______ will ______ in order to return output to the natural
level.
A) price level; increase
B) interest rate; decrease
C) money supply; increase
D) consumption function; decrease

Use the following to answer questions 30-31:

Exhibit: Short Run to Long Run

30. (Exhibit: Short Run to Long Run) Based on the graph, if the economy starts from a
short-term equilibrium at A, then the long-run equilibrium will be at ____ with a _____
price level.
A) B; higher
B) B; lower
C) C; higher
D) C; lower

31. (Exhibit: Short Run to Long Run) Based on the graph, if the economy starts from a
short-term equilibrium at D, then the long-run equilibrium will be at ____ with a _____
price level.
A) B; higher
B) B; lower
C) C; higher
D) C; lower
32. The Pigou effect suggests that falling prices will increase income because real balances
influence ______ and will shift the ______ curve.
A) money demand; LM
B) the money supply; LM
C) consumer spending; IS
D) government spending; IS

33. During the financial crisis of 2008–2009, many financial institutions stopped making
loans even to creditworthy customers, which could be represented in the IS–LM model
as a(n):
A) expansionary shift in the IS curve.
B) contractionary shift in the IS curve.
C) expansionary shift in the LM curve.
D) contractionary shift in the LM curve.

34. A liquidity trap occurs when:

A) banks have too much currency and close their doors to new customers.
B) the central bank mistakenly prints too much money, generating hyperinflation.
C) interest rates fall so low that monetary policy is no longer effective.
D) dams and locks are built to prevent flooding.

35. 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.

36. 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

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

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

38. If the IS curve is given by Y = 1,700 – 100r, the money demand function is given by
(M/P)d = Y – 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.
39. 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

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

41. If the government wants to raise investment but keep output constant, it should:
A) adopt a loose monetary policy but keep fiscal policy unchanged.
B) adopt a loose monetary policy and a loose fiscal policy.
C) adopt a loose monetary policy and a tight fiscal policy.
D) keep monetary policy unchanged but adopt a tight fiscal policy.

42. A tax cut combined with tight money, as was the case in the United States in the early
1980s, should lead to a:
A) rise in the real interest rate and a fall in investment.
B) fall in the real interest rate and a rise in investment.
C) rise in both the real interest rate and investment.
D) fall in both the real interest rate and investment.
43. Assume the following model of the economy, with the price level fixed at 1.0:
C = 0.8(Y – T) T = 1,000
I = 800 – 20r G = 1,000
Y=C+I+G Ms/P = Md/P = 0.4Y – 40r
s
M = 1,200

a. Write a numerical formula for the IS curve, showing Y as a function of r alone. (Hint:
Substitute out C, I, G, and T.)

b. Write a numerical formula for the LM curve, showing Y as a function of r alone. (Hint:
Substitute out M/P.)
c. What are the short-run equilibrium values of Y, r, Y – T, C, I, private saving, public
saving, and national saving? Check by ensuring that C + I + G = Y and national saving
equals I.
d. Assume that G increases by 200. By how much will Y increase in short-run
equilibrium? What is the government-purchases multiplier (the change in Y divided by
the change in G)?
e. Assume that G is back at its original level of 1,000, but Ms (the money supply)
increases by 200. By how much will Y increase in short-run equilibrium? What is the
multiplier for money supply (the change in Y divided by the change in Ms)?

44. Assume that an economy is characterized by the following equations:

C = 100 + (2/3)(Y – T)
T = 600
G = 500
I = 800 – (50/3)r
Ms/P = Md/P = 0.5Y – 50r
a. Write the numerical IS curve for the economy, expressing Y as a numerical function of
G, T, and r.
b. Write the numerical LM curve for this economy, expressing r as a function of Y and
M/P.
c. Solve for the equilibrium values of Y and r, assuming P = 1.0 and M = 1,200. How do
they change when P = 2.0? Check by computing C, I, and G.
d. Write the numerical aggregate demand curve for this economy, expressing Y as a
function of G, T, and M/P.
45. Assume that an economy is described by the IS curve Y = 3,600 + 3G – 2T – 150r and the LM
curve Y = 2 M/P + 100r [or r = 0.01Y – 0.02(M/P)]. The investment function for this economy is
1,000 – 50r. The consumption function is C = 200 + (2/3)(Y – T). Long-run equilibrium output
for this economy is 4,000. The price level is 1.0.
a. Assume that government spending is fixed at 1,200. The government wants to achieve a
level of investment equal to 900 and also achieve Y = 4,000. What level of r is needed
for I = 900? What levels of T and M must be set to achieve the two goals? What will be
the levels of private saving, public saving, and national saving? (Hint: Check C + I + G
= Y.)
b. Now assume that the government wants to cut taxes to 1,000. With G set at 1,200, what
will the interest rate be at Y = 4,000? What must be the value of M? What will I be?
What will be the levels of private, public, and national saving? (Hint: Check C + I + G =
Y.)
c. Which set of policies may be referred to as tight fiscal, loose money? Which set of
policies may be referred to as loose fiscal, tight money? Which “policy mix” most
encourages investment?

46. Suppose Congress wishes to reduce the budget deficit by reducing government
spending. Use the IS–LM model to illustrate graphically the impact of the reduction in
government spending on output and interest rates. Be sure to label: i. the axes; ii. the
curves; iii. the initial equilibrium values; iv. the direction the curves shift; and v. the
terminal equilibrium values.

47. Use the IS–LM model to illustrate graphically the impact on output and interest rates of
a one-time increase in the price level due to a large increase in oil prices. Be sure to
label: i. the axes; ii. the curves; iii. the initial equilibrium values; iv. the direction the
curves shift; and v. the terminal equilibrium values.
48. Two identical countries, Alpha and Beta, can be described by the IS–LM model in the
short run. The governments of both countries cut taxes by the same amount. The Central
Bank of Alpha follows a policy of holding a constant money supply. The Central Bank
of Beta follows a policy of holding a constant interest rate. Compare the impact of the
tax cut on income and interest rates in the two countries.

49. Use the IS–LM model to predict the short-run impact on the interest rate and output if
the Fed pushes interest rates down at the same time that both consumption and
investment fall due to a financial crisis. Illustrate your answer graphically. Be sure to
label: i. the axes; ii. the curves; iii. the initial equilibrium; and iv. the direction the
curves shift. Explain your answer in words.

50. The LM curve can shift to the right if there is an increase in the supply of money or a
fall in the price level. In which case is this movement along the aggregate demand
curve, and in which case is this a shift of the aggregate demand curve? Explain.

51. Suppose that people finally realize that they must save a larger proportion of their
income in order to retire and that they simultaneously begin to use new technology that
allows them to reduce their holdings of real cash balances as a proportion of their
income. Use the IS–LM model to illustrate graphically the impact of these two changes
in household behavior on output and interest rates. Be sure to label: i. the axes; ii. the
curves; iii. the initial equilibrium values; iv. the direction the curves shift; and v. the
terminal equilibrium values.

52. Consider a closed economy to which the Keynesian-cross analysis applies.

Consumption is given by the equation C = 200 + 2/3(Y – T). Planned investment is 300,
as are government spending and taxes.
a. If Y is 1,500, what is planned spending? What is inventory accumulation or
decumulation? Should equilibrium Y be higher or lower than 1,500?
b. What is equilibrium Y? (Hint: Substitute the values of equations for planned
consumption, investment, and government spending into the equation Y = C + I + G
and then solve for Y.)
c. What are equilibrium consumption, private saving, public saving, and national
saving?
d. How much does equilibrium income decrease when G is reduced to 200? What is the
multiplier for government spending?

53. a. Suppose Congress decides to reduce the budget deficit by cutting government
spending. Use the Keynesian-cross model to illustrate graphically the impact of a
reduction in government purchases on the equilibrium level of income. Be sure to
label: i. the axes; ii. the curves; iii. the initial equilibrium values; iv. the direction the
curve shifts; and v. the terminal equilibrium values.
b. Explain in words what happens to equilibrium income as a result of the cut in
government spending and the time horizon appropriate for this analysis.
54. a. Suppose Congress passes legislation that significantly reduces taxes. Use the Keynesian-
cross model to illustrate graphically the impact of a reduction in taxes on the equilibrium
level of income. Be sure to label: i. the axes; ii. the curves; iii. the initial equilibrium values;
iv. the direction the curve shifts; and v. the terminal equilibrium values.
b. Explain in words what happens to equilibrium income as a result of the tax cut and the time
horizon appropriate for this analysis.

55. a. Use the Keynesian-cross model to illustrate graphically the impact of an increase in
the interest rate on the equilibrium level of income. Be sure to label: i. the axes; ii.
the curves; iii. the initial equilibrium values; iv. the direction the curve shifts; and
v. the terminal equilibrium values.
b. Explain in words what happens to equilibrium income as a result of the increase in
the interest rate.

56. a. Graphically illustrate the impact of an open-market purchase by the Federal

Reserve on the equilibrium interest rate using the theory of liquidity preference and
the market for real money balances. Be sure to label: i. the axes; ii. the curves; iii.
the initial equilibrium values; iv. the direction the curve shifts; and v. the terminal
equilibrium values.
b. Explain in words what happens to the equilibrium interest rate as a result of the
open-market purchase.

57. a. As an economy moves into a recession, income falls. Illustrate graphically the
impact of a decrease in income on the equilibrium interest rate using the theory of
liquidity preference and the market for real money balances. Be sure to label: i. the
axes; ii. the curves; iii. the initial equilibrium values; iv. the direction the curve
shifts; and v. the terminal equilibrium values.
b. Explain in words what happens to the equilibrium interest rate as a result of the fall
in income.

58. In explaining the 2003 bill to cut taxes, President Bush is quoted as saying, “When
people have more money, they can spend it on goods and services.”
a. In the IS–LM model, will a tax cut change the money supply in the economy? Does
a change in the money supply shift the IS or the LM curve?
b. In the IS–LM model, does a tax cut shift the IS or the LM curve?
c. Based on your answers in a and b, how can you reconcile the president's statement
with economics? Can you suggest how his statement could be modified to be
consistent with the IS–LM model?

59. Two identical countries, Country A and Country B, can each be described by a
Keynesian-cross model. The MPC is 0.9 in each country. Country A decides to
increase spending by $2 billion, while Country B decides to cut taxes by $2 billion. In
which country will the new equilibrium level of income be greater?
60. Explain why a decrease in planned investment, which is a change in the goods market,
will upset the equilibrium in the money market.

61. Explain why an increase in the money supply, which is a change in the money market,
will upset the equilibrium in the goods market.

62. During a recession, consumers may want to save more to provide themselves with a
reserve to cushion possible job losses. Use the Keynesian model to describe the impact
of an exogenous decrease in consumption (a decrease in C) on the equilibrium level of
income in the economy.