MULTIPLE CHOICE: THE IS-LM MODEL

1) The IS curve will shift to the right when which of the

following occurs?
A) an increase in the money supply NO
B) an increase in government spending. Yes +1
C) a reduction in the interest rate. NO
D) all of the above NO
E) none of the above

2) Which of the following occurs as the economy moves

leftward along a given IS curve?
A) An increase in the interest rate causes investment spending to
decrease. YES
B) An increase in the interest rate causes money demand to increase.
NO
C) An increase in the interest rate causes a reduction in the money
supply. NO
D) A reduction in government spending causes a reduction in demand
for goods.
E) An increase in taxes causes a reduction in demand for goods. NO

3) For this question, assume that investment spending

depends only on the interest rate and no longer depends on
output. Given this information, a reduction in government
spending
A) will cause investment to decrease.
This option is incorrect because, according to the problem statement,
investment is not affected by changes in government spending when it
depends solely on the interest rate. Therefore, a decrease in government
spending does not automatically lead to a decrease in investment.
B) will cause investment to increase. NO
C) may cause investment to increase or to decrease.
D) will have no effect on output. This option is also incorrect. A
reduction in government spending will likely lead to a decrease in
aggregate demand, which can subsequently reduce output (Y) in the
short run. However, the output does depend on various other factors,
including consumption, investment, and net exports.
E) will cause a reduction in output and have no effect on investment
This is the correct answer. A decrease in government spending will lower
aggregate demand, leading to a reduction in output (Y) as firms respond
to lower demand for goods and services. However, since investment is
assumed to depend only on the interest rate, it will remain unaffected by
changes in government spending.

4) Suppose investment spending is not very sensitive to the

interest rate. Given this information, we know that
A) the IS curve should be relatively flat. NO
B) the IS curve should be relatively steep. +1
C) the LM curve should be relatively flat.
D) the LM curve should be relatively steep. NO
E) neither the IS nor the LM curve will be affected.

5) For each interest rate, the LM curve illustrates the level of

output where…
A) the goods market is in equilibrium. NO
B) inventory investment equals zero. NO
C) money supply equals money demand. YES. +1
D) all of the above NO
E) none of the above

7) Suppose the economy is operating on the LM curve but not

on the IS curve. Given this information, we know that
A) the goods market is in equilibrium and the money market is not in
equilibrium. Maybe
B) the money market and bond markets are in equilibrium and the
goods market is not in equilibrium. NO
we know that the economy is on the LM curve, meaning the money
market is in equilibrium. but there is no information about the bond
market. However, since we know that the goods market is not in
equilibrium, this statement could be possible if the bond market were
also in equilibrium.
C) the money market and goods market are in equilibrium and the
bond market is not in equilibrium. NO
D) the money, bond and goods markets are all in equilibrium. NO
E) neither the money, bond, nor goods markets are in equilibrium.
Maybe

8) Suppose there is a fiscal contraction(austérité budgétaire). Which of

the following is a complete list of the variables that must
decrease?
A) consumption
B) consumption and investment
C) consumption and output
D) consumption, output and the interest rate
E) consumption, output and investment YES +1

9) We know with certainty that a tax increase must cause

which of the following?
A) an increase in investment NO
B) a reduction in investment YES +1
C) no change in investment NO
D) none of the above Maybe

10) An increase in the money supply must cause which of the

following?
A) a leftward shift in the IS curve NO
B) a reduction in the interest rate and ambiguous effects on
investment Positive effect NO Positive effect
C) an increase in investment and a rightward shift in the IS curve YES
D) no change in the interest rate if investment is independent of the
interest rate NO
E) no change in output if investment is independent of the interest
rate NO
Explanation: Correct. If investment is independent of interest rates, then
even with an increase in the money supply, output would remain
unchanged. This is because investment is a key driver of output in the
economy; if it does not respond to the change in the interest rate (due to
an increased money supply), then output won’t change as a result.

11) A reduction in consumer confidence will likely have which

of the following effects?
A) a rightward shift in the IS curve NO
B) a leftward shift in the IS curve Yes. + 1
C) an upward shift in the LM curve NO
D) a downward shift in the LM curve NO

12) The IS curve will not shift when which of the following
occurs?
A) a reduction in government spending NO
B) a reduction in the interest rate NO
Conclusion: A reduction in the interest rate does not shift the IS
curve; it results in a movement along the curve (YES).
C) a reduction in consumer confidence Yes
D) all of the above NO
E) none of the above YES

13) A reduction in the reserve deposit ratio, θ, will most likely

have which of the following effects?
A) a rightward shift in the IS curve
B) a leftward shift in the IS curve
C) an upward shift in the LM curve
D) a downward shift in the LM curve

14) If government spending and taxes decrease by the same

amount,
A) the IS curve does not shift.
B) the IS curve shift leftward.
Therefore, if government spending and taxes decrease by the same
amount, the IS curve shifts leftward due to the larger impact of the decrease
in government spending compared to the increase in consumption from
the tax cut.
C) the IS curve shifts rightward.
D) the LM curve shifts downward.

15) Which of the following occurs as the economy moves

rightward along a given IS curve?
A) A reduction in the interest rate causes investment spending to
increase. YES. +1
B) A reduction in the interest rate causes money demand to decrease.
NO
C) A reduction in the interest rate causes a reduction in the money
supply. NO
D) An increase in government spending causes a reduction in demand
for goods. NO
E) A reduction in taxes causes a reduction in demand for goods. NO
ANSWERS: 1) B; 2) A; 3) E; 4) B; 5) C; 7) B; 8) E; 9) B; 10) E; 11) B; 12)
B; 13) D; 14) B; 15) A.