Fall 2006 (IS – LM Model) Econ 100B 1 of 8Name: ________ANSWERS__________ SID : ____________________________ Discussion Section: ________________ Economic 100B Macroeconomic Analysis Professor Steven Wood Fall 2006 Exam #2 ANSWERS Please sign the following oath: The answers on this test are entirely my own work. I neither gave nor received any aid while taking this test. I will not discuss the questions on this test until after 5:00 p.m. on November 2, 2006. ______________________ Signature Any test turned in without a signature indicating that you have taken this oath will be assigned a grade of zero. Graph Instructions When drawing diagrams, the following rules apply: a. Completely, clearly and accurately label all axis, lines, curves, and equilibrium points. b. The original diagram and equilibrium points MUST be drawn in black or pencil. c. The first shift of any line(s) and the new equilibrium points MUST be drawn in red. d. The second shift of any line(s) and new equilibrium points MUST be drawn in blue e. The third shift of any line(s) and new equilibrium points MUST be drawn in green. Do NOT open this test until instructed to do so. Good Luck!Fall 2006 (IS – LM Model) Econ 100B 2 of 8 This page intentionally left blank.Fall 2006 (IS – LM Model) Econ 100B 3 of 8A. Multiple Choice Questions. Mark the letter corresponding to the best answer in the corresponding space at the bottom of the page. (3 points each; total of 30 points.) 1. Suppose that there is a sudden rise in the interest rate. This could have been due to: a. A fall in the monetary base. b. An increase in government expenditures. c. A rise in the money supply. d. a. or b. e. b. or c. 2. In the IS – LM Model, the level of equilibrium income is ultimately determined by: a. The level of the money supply. b. The level of the monetary base. c. The level of aggregate demand in the economy. d. The level of consumption. e. The level of investment. 3. Suppose that the unemployment rate is at the NAIRU and that the government wishes to raise tax revenues this year to reduce its debt-to-GDP ratio. The best way to raise this tax revenue so as to keep output as close as possible to potential would be: a. To cut government spending programs. b. A permanent rise in the level of income taxation. c. A temporary rise in the level of income taxation. d. To raise taxes on those with a high marginal propensity to consume. e. Either a. or b. 4. According to real business cycle theory, a rise in government expenditures brings about a fall in consumption because people feel poorer due to the prospects of future tax increases. If this theory is correct, then the net effect of a rise in government expenditures would be to cause: a. The IS curve to shift outwards. b. The IS curve to shift inwards. c. The IS curve to flatten. d. Either b. or c. e. Either a. or b. 5. Suppose that business firms become less reliant on internally generated cash flow for investment and more reliant on loans from banks. We could represent this as: a. A flattening of the IS curve, making monetary policy more powerful. b. A steepening of the IS curve, making monetary policy more powerful. c. A flattening of the IS curve, making monetary policy less powerful. d. A steepening of the IS curve, making monetary policy less powerful. e. None of the above. __d__ __c__ __c__ __e__ __a__ 1 2 3 4 5Fall 2006 (IS – LM Model) Econ 100B 4 of 86. Suppose that the Federal Reserve always maintains the interest rate at a fixed level. Then, if unemployment is at the NAIRU and autonomous consumption suddenly increases, the Fed will have to: a. Reduce the money multiplier. b. Reduce the monetary base. c. Keep the money multiplier constant. d. Engage in policy to increase output beyond potential. e. Engage in policy to reduce unemployment. 7. Suppose that a rise in stock prices induces wealth effects that cause people to leave the labor force and thereby reduce potential output. If the Federal Reserve follows a stabilizing policy and stock prices rise, then it will have to: a. Reduce the money supply. b. Increase the money supply. c. Lower interest rates. d. Raise the monetary base. e. Raise the money multiplier. 8. In the IS – LM Model, a rise in autonomous exports will have all of the following effects EXCEPT: a. Shift the IS curve outward. b. Reduce the unemployment rate by Okun’s Law. c. Increase real GDP. d. Increase the cyclical budget balance. e. Increase the structural budget balance. 9. Some recent research has shown that fiscal policy has only a small effect on aggregate output. This would suggest that: a. There is a lot of crowding out. b. The fiscal policy multiplier is small. c. The money multiplier is large. d. Either a. or b. e. Either a. or c. 10. If the economy suddenly went into a recession, the “most effective” policy prescription in reaction to this would be to: a. Permanent tax cuts for wealthy people. b. Permanent tax cuts for poor people. c. Reductions in the budget deficit. d. Permanent tax cuts for business firms. e. Temporary tax cuts for wealthy people. __d__ __a__ __e__ __d___ __b__ 6 7 8 9 10 B. IS - LM Model Problems. Answer BOTH of the following questions in the space below.Fall 2006 (IS – LM Model) Econ 100B 5 of 81. Suppose that the economy has a large cyclical budget deficit and the central bank engages in substantial open market sales of government securities. As a result, the stock market falls substantially, destroying a significant amount of consumer wealth. In addition, the foreign exchange value of the dollar increases, greatly reducing net exports. (35 points.) a. Based only on this information, use an IS – LM Model diagram with an Okun’s Law diagram to accurately and clearly show the effects of the change in monetary policy (in red), the change in wealth (in blue), and the change in net exports (in green) on equilibrium income, the interest rate, and the unemployment rate. R R1 R2 R0 R3 LM2 LM1 IS2IS3U U3 U2 U1 U0 Un Y3 Y2Y1 Y0 Yn