**Econ 375
Sample Exam 2**

**Part I: Multiple Choice.**

1. The IS curve plots the relationship between interest rates
and ____ that arises in the market for _____.

a) national income; goods

b) the price level; goods

c) national income; money

d) the price level; money

2. An explanation for the slope of the IS curve is that as the
interest rate increases:

a) the quantity of investment increases, and this shifts the
expenditure function downward, decreasing income.

b) the quantity of investment increases, and this shifts the
expenditure function upward, increasing income.

c) the quantity of investment decreases, and this shifts the
expenditure function upward, increasing income.

d) the quantity of investment decreases, and this shifts the
expenditure function downward, decreasing income.

3. When the LM curve is drawn, the quantity that is held fixed
is:

a) the nominal money supply

b) the real labor supply

c) government spending

d) the tax rate

4. An explanation of the slope of the LM curve is that:

a) as the interest rate increases, income becomes higher.

b) as the interest rate increases, income becomes lower.

c) as income rises, money demand rises, and a higher interest
rate results.

d) as income rises, money demand falls, and a lower interest rate
results.

5. According to the IS-LM model, when taxes are increased, the
interest rate:

a) rises and output falls

b) rises and output rises

c) falls and output rises.

d) falls and output falls.

6. Start from long-run equilibrium, if the velocity of money
increases (due to, for instance, the invention of automatic
teller machines) and no action is taken by the government:

a) prices will rise both in the short run and the long run.

b) output will rise both in the short run and the long run.

c) prices will rise in the short run, and output will rise in the
long run.

d) output will rise in the short run, and prices will rise in the
long run.

7. The AD curve generally slopes downward and to the right
because, for any given money supply M:

a) a higher price level P causes a lower real money supply M/P,
which raises the interest rate and reduces spending.

b) a higher price level P increases the real money supply M/P,
which lowers the interest rate and increases spending.

c) a higher price level P causes a lower real money supply M/P,
which lowers the interest rate and increases spending.

d) a higher price level P increases the real money supply M/P,
which raises the interest rate and reduces spending.

**Part II: Answer three questions.**

8. Explain how a change in monetary policy affects real GDP using the IS-LM model. Do not use any graphs.

9. According to the IS-LM model, what happens to the interest
rate, income, consumption, and investment in the short run under __each
__of the following situations? [No explanation is necessary;
just tell me whether the variable increases, decreases, or is
unaffected.]

a) there is an exogenous decrease in money demand

b) the government increases taxes

10. Suppose that OPEC (the oil cartel) suddenly collapsed and oil prices plummeted. Describe what happens in the short-run and the long-run using the AD-AS model and assuming that policymakers do not react. Illustrate your argument with the appropriate graph. (You may assume that the economy is initially in long run equilibrium.)

11. Suppose that the government wants to raise output but keep interest rates constant. In the IS-LM model, what mix of monetary and fiscal policy will achieve this goal? Explain and illustrate with the appropriate graph.

**Part III: Answer this question.**

12. Assume that the following model describes the economy, with the price level fixed at 1.00 in the short run.

Y = C + I + G

C = 300 + 0.8(Y-T)

I = 1200 - 50r

G = 1500

T = 1500

Ms/P = Md/P = 0.5Y - 50r

Ms = 2750

a) Write down the equations for the IS curve and the LM curve.

b) What are the short-run equilibrium values of Y, r, C, and I?

c) Illustrate the short run equilibrium with an IS-LM graph and
an AD-AS graph.

d) Assume that the full employment level of GDP is $7000. How
would you describe the current state of the economy relative to
this full employment level?

e) Assuming no changes in government policy, what would happen to
the price level in the long run? What would happen to the
interest rate in the long run? What would happen to GDP in the
long run? (No mathematical calculations are necessary here--just
illustrate the changes on the diagram above.)

Answers are HERE