1.)    According to the IS-LM model, what happens to the interest rate, income, consumption, and investment when

a)      The central bank increases the money supply?

b)      The government increases government purchases?

c)       The government increases taxes?

d)      The government increases purchases and taxes by equal amounts?

2.)    Explain why each of the following statements is true. Discuss the impact of monetary and fiscal policy in each of these special cases.

a)      If investment does not depend on the interest rate, the IS curve is vertical.

b)      If money demand does not depend on the interest rate, the LM curve is vertical.

c)       If money demand does not depend on income, the LM curve is horizontal.

d)      If money demand is extremely sensitive to the interest rate, the LM curve is horizontal.

3.)    Suppose that the government wants to raise investment but keep output constant. In the IS-LM model, what mix of monetary and fiscal policy will achieve this goal? In the early 1980’s, the US government cut taxes and ran a budget deficit while the Fed pursued tight monetary policy. What effect should this policy mix have?

4.)    Use the IS-LM diagram to describe the short-run and long-run impact on national income, the price level, and the interest rate of

a)      An increase in the money supply.

b)      An increase in government purchases.

c)       An increase in taxes.

5.)    The Fed is considering two alternative monetary policies:

·         Holding the money supply constant

·         Adjusting the money supply to hold the interest rate constant

In the IS-LM model, which policy will better stabilize output if

a)      All shocks to the economy arise from exogenous exchanges in the demand for goods and services?

b)      All shocks to the economy arise from exogenous exchanges in the demand for money?