Question 1

According to the IS/LM model, what is the immediate effect of an increase in the money supply on the interest rate and investment?

Accepted Answer

Interest rates fall and investment rises.

Question 2

Which of the following best describes the 'crowding out' effect in the context of fiscal policy?

Accepted Answer

Government spending leads to higher interest rates, reducing private investment.

Question 3

Given the fiscal policy multiplier $ \Delta Y = \frac{1}{1-b} \Delta G $, what does $b$ represent in this equation?

Accepted Answer

The marginal propensity to consume.

Question 4

Under what conditions is monetary policy most effective according to the IS/LM framework?

Accepted Answer

When the IS curve is flat and the LM curve is steep.

Question 5

If the government increases taxes, the change in income is given by $ \Delta Y = -\frac{b}{1-b} \Delta T $. What is the economic interpretation of the negative sign?

Accepted Answer

An increase in taxes decreases income.

Question 6

In the IS/LM model, what happens to the equilibrium income and interest rate if both government spending and the money supply increase simultaneously?

Accepted Answer

Income rises, but the effect on interest rates depends on the relative magnitudes of the shifts.

Question 7

Why is fiscal policy considered more effective in a liquidity trap?

Accepted Answer

Because changes in the money supply do not affect interest rates or output.

Question 8

Which school of thought believes the LM curve is vertical, implying monetary policy is always effective?

Accepted Answer

Classical

Question 9

Suppose the marginal propensity to consume ($b$) is 0.8. If government spending increases by $100$, what is the predicted change in income ($\Delta Y$) according to the multiplier formula $\Delta Y = \frac{1}{1-b} \Delta G$?

Accepted Answer

$\Delta Y = 500$

Question 10

If the LM curve is relatively flat, what does this imply about the interest elasticity of money demand?

Accepted Answer

Money demand is highly sensitive to changes in the interest rate.

Question 11

Which of the following scenarios best illustrates 'crowding in'?

Accepted Answer

Monetary policy lowers interest rates, stimulating private sector investment.

Question 12

According to the IS/LM model, what is the effect of an increase in government spending on the IS curve?

Accepted Answer

It shifts the IS curve to the right.

Question 13

If the marginal propensity to consume ($b$) is 0.6, by how much will income decrease if taxes increase by $50$? Use $\Delta Y = -\frac{b}{1-b} \Delta T$.

Accepted Answer

$\Delta Y = -75$

Question 14

Which of the following best describes the effectiveness of fiscal policy when the LM curve is steep?

Accepted Answer

Fiscal policy is less effective because interest rates rise significantly, causing crowding out.

Question 15

In the IS/LM model, what is the likely outcome if the central bank increases the money supply while the government simultaneously increases taxes?

Accepted Answer

The increase in money supply may offset the contractionary effect of higher taxes, leading to ambiguous effects on income.

Question 16

Which of the following is a key feature of a liquidity trap?

Accepted Answer

Interest rates are very low and monetary policy is ineffective.

Question 17

If the IS curve is relatively flat, what does this imply about the interest elasticity of investment?

Accepted Answer

Investment is highly sensitive to changes in the interest rate.

Question 18

Which policy mix is most likely to prevent crowding out when using fiscal expansion?

Accepted Answer

Fiscal expansion with an accommodating (expansionary) monetary policy.

Question 19

According to Keynes, why was fiscal policy particularly important in the aftermath of the Great Depression?

Accepted Answer

Because the economy was in a situation where monetary policy was ineffective and fiscal policy could stimulate demand.

Keynesian Policy Analysis and the IS/LM Model

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