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Chapter 33


True/False
Indicate whether the statement is true or false.
 

 1. 
Keynes’ General Theory was an attempt to explain how economies operate at equilibrium in the long run.
 

 2. 
Keynes believed that a key element of unemployment was a deficiency in the level of aggregate demand which governments could and should rectify.
 

 3. 
Classical economists believed that markets would not clear quickly, including the labour market, causing long-term unemployment.
 

 4. 
Planned spending includes the intended or desired spending by households and firms in the economy.
 

 5. 
In an open economy, planned spending and actual spending will always be equal because they are an identity.
 

 6. 
On a Keynesian cross diagram, the 45 degree line connects all points where consumption spending would be equal to national income .
 

 7. 
A deflationary gap exists when there is a difference between the price level in an economy and a fall in the level of national income.
 

 8. 
Autonomous spending is the proportion of income which consumers have to spend on items necessary for normal life such as mortgages and food.
 

 9. 
If the economy was in equilibrium where an inflationary gap existed then Keynes would argue that governments should cut public spending and increase taxation to reduce the expenditure line to reduce the gap.
 

 10. 
The IS curve measures points where the inflation rate and national income are the same .
 

 11. 
The IS curve will be flatter the more responsive consumption and investment are to changes in interest rates.
 

 12. 
The LM curve connects points where the money market is in equilibrium and the demand for money is equal to the supply of money at different interest rates.
 

 13. 
An increase in the demand for money causes a shift of the demand for money curve to the right and a movement along the LM curve reflecting a higher interest rate and level of national income.
 

 14. 
General equilibrium refers to a situation when there is no tendency to change in all macro and microeconomic markets in an economy.
 

 15. 
A cut in autonomous spending would lead to a shift of the S curve to the right and result in a higher interest rate and level of national income.
 

Multiple Choice
Identify the choice that best completes the statement or answers the question.
 

 16. 
Which of the following statements about Keynesian views is true?
a.
Keynes’ analysis was mainly concerned with the long-run
b.
Keynes fully supported the classical view that markets were efficient and cleared quickly
c.
Demand deficient output meant that governments had a responsibility to boost demand to maintain full employment in the short term
d.
Responsibility for fiscal policy should be transferred to central banks because governments could not be trusted to implement tax changes appropriately in times of recession.
 

 17. 
A key element of Keynesian analysis relates to:
a.
policies to reduce the difference between planned and actual spending and investment
b.
using taxation as a means to influence the interest rate in an economy.
c.
The similarities between short term fluctuations in macroeconomic variables and how they behave in the long run
d.
the distinction between planned spending and investment and actual spending and investment
 

 18. 
Which of the following statements about the 45 degree line is true?
a.
The 45 degree line cuts the vertical axis at the level of autonomous expenditure in the economy.
b.
The 45 degree line connects all points where interest rates and national income are equal.
c.
The slope of the 45 degree line is determined by the marginal propensity to consume.
d.
A steeper 45 degree line indicates an inflationary gap.
e.
The 45 degree line connects all points where consumption spending would equal national income.
 

 19. 
A deflationary gap occurs because
a.
Governments set full employment output at too high a level.
b.
Prices in the economy are too low to ensure that all resources are fully utilized in the economy.
c.
The level of expenditure in an economy is less than that needed to maintain full employment output.
d.
Planned spending turns out to equal actual spending above full employment output
e.
There are not enough resources in the economy to meet consumption requirements.
 

 20. 
The multiplier model implies that
a.
additional spending by the government will be a multiple of the tax rise needed to fund the spending.
b.
changes in autonomous spending will lead to an increase in national income which is greater than the initial increase in spending.
c.
changes in government spending will always lead to a proportionate increase in national income.
d.
there are no leakages from the circular flow of income.
e.
aggregate demand rises by a constant multiple of the change in consumption spending.
 

 21. 
The government increases spending by €10 billion during a time of economic slowdown when output is less than full employment output. The marginal propensity to withdraw is 0.9. What is the value of the multiplier?
a.
0.1
c.
1.1
b.
0.9
d.
10
 

 22. 
Which of the following will not weaken the value of the multiplier in an economy in response to a change in autonomous spending?
a.
A rise in net imports.
b.
A fall in the marginal propensity to consume.
c.
An increase in the proportion of tax taken of every euro earned
d.
An increase in the interest rate
 

 23. 
The slope of the expenditure line is dependent upon:
a.
the marginal propensity to consume.
b.
the marginal efficiency of capital.
c.
how far the government decide to increase autonomous expenditure.
d.
the slope of the 45 degree line.
 

 24. 
If the economy is suffering from demand deficient unemployment then Keynes would recommend
a.
Cutting long term interest rates in order to boost investment.
b.
increasing the level of government spending to shift the expenditure line upwards.
c.
Changing the marginal propensity to consume to bring about equilibrium in the economy at full employment output.
d.
Increasing imports to help boost national income by shifting the expenditure line upwards.
 

 25. 
General equilibrium in an economy occurs:
a.
at a particular interest rate where the goods market and the money market are both in equilibrium.
b.
when the equilibrium level of national income in the goods market is the same as that in the money market at full employment output.
c.
when interest rates in the money market and the financial markets are the same.
d.
when investment equals saving.
 

 26. 
IS stands for:
a.
Investment and Spending
c.
Interest and Saving
b.
Imports and Spending.
d.
Investment and Saving.
 

 27. 
The slope of the IS curve is dependent upon:
a.
the marginal propensity to save
b.
the slope of the expenditure line from which it is derived.
c.
how often the central bank changes interest rates.
d.
the proportionate change in autonomous spending
e.
the responsiveness of consumption and investment to changes in interest rates.
 

 28. 
A shift in the LM curve can occur because
a.
interest rates change so frequently.
b.
of contractions and expansions in the money supply.
c.
of the strength of the velocity of circulation.
d.
of a shift in the demand for money.
 

 29. 
Assume that the economy is in equilibrium at an interest rate and level of national income where the IS curve cuts the LM curve. A large cut in government spending would be expected to:
a.
increase interest rates and the level of national income.
b.
reduce interest rates but increase the level of national income.
c.
reduce interest rates and the level of national income.
d.
shift the IS curve to the right.
e.
leave the economy in an unchanged position because the marginal propensity to consume is constant.
 

 30. 
Assume a central bank has been charged with maintaining the price level at a rate of 2 per cent. For the past twelve months the inflation rate has been at target and interest rates have been stable but the government has been concerned over signs of a slowdown in economic activity. As a result the government has decided to increase its spending on infrastructure projects. If the central bank wishes to maintain interest rates (and inflation) at a stable rate what should it do in the light if this decision?
a.
Nothing as changes in government spending on infrastructure does not affect consumer price inflation.
b.
Expand the money supply to maintain interest rates at a level consistent with its forecast of consumer price inflation.
c.
Reduce the money supply by an equal amount to counteract the increase in government spending.
d.
Persuade the government that any additional spending must be financed purely by taxation so that monetary policy does not have to change.
 

 31. 
The supply of real money balances is given by the equation:
a.
MV = PY
b.
MP x 1/y
c.
1 / (1-MP)
d.
M/P
e.
P x M
 

 32. 
One of the main sources of disagreement amongst economists about macroeconomic policy is:
a.
a fundamental disagreement about the role of taxation.
b.
how far and how quickly macroeconomic variables adjust in response to changing economic conditions .
c.
whether the marginal propensity to consume can be calculated accurately.
d.
the fact that the IS-LM model has no relevance at all to a modern developed economy.
 

 33. 
If a central bank wants to reduce interest rates it will instruct its traders to:
a.
instruct all financial institutions to adjust rates accordingly.
b.
reduce liquidity in financial markets.
c.
buy bonds on the open market.
d.
carry out open market operations by buying shares on the stick exchange.
 

 34. 
In the IS-LM model the money supply is assumed to be:
a.
determined by the interest rate.
c.
fixed by the government.
b.
endogenous.
d.
exogenous.
 

 35. 
The IS-MP model differs from the IS-LM model in that it is assumed
a.
central banks target inflation and set interest rates to meet such a target.
b.
the money supply is endogenous.
c.
price and wage stickiness do not exist.
d.
governments instruct central banks on the level of the money supply and interest rates.
 



 
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