a.
To explain:The main determinants of investment are the level of sales and the interest rate.
a.
Answer to Problem 1QAP
True that the main determinants of investment are the level of sales and the interest rate.
Explanation of Solution
Firms with low level of sales will not required to invest further while firms with high level of sales is required to invest in order to continue the servicing of these sales. Higher the interest rate, the cost of borrowing will increase which further leads to decrease in the level of investment.
Introduction: There is a direct relationship between level of sales and level of investment and inverse relationship between interest rate and level of investment.
b.
To explain: Higher level of output can be achieved only by lowering the interest rate, if all the exogenous variables in the IS relation are constant.
b.
Answer to Problem 1QAP
True that higher level of output can be achieved only by lowering the interest rate, if all the exogenous variables in the IS relation are constant.
Explanation of Solution
The Central bank influence the borrowing and lending by lowering the interest rate which further leads to increase in the output. Assuming if all the exogenous variables in the IS relation are constant.
Introduction:The IS relation shows that how the income depends on the interest rate through the relationship between demand and supply in the goods market.
c.
To explain: The IS curve is downward sloping because goods market equilibrium.
c.
Answer to Problem 1QAP
False that the IS curve is downward sloping because goods market equilibrium does notimply that an increase in taxes leads to lower level of output.
Explanation of Solution
IS curve indicates that with an increase in interest rate output decreases. Similarly with decrease in interest rate output increases which cause the downward sloping of IS curve.
Introduction: The IS curve represents all the combination of income and the real interest rate such that the market for goods and services is in equilibrium.
d.
To explain: If government spending and taxes increase by the same amount, the IS curve does not shift.
d.
Answer to Problem 1QAP
Uncertain that if government spending and taxes increase by the same amount, the IS curve does not shift.
Explanation of Solution
There might be a shift in the IS curve as a decrease in taxes that is completely offset by an increase in government spending.
Introduction: The IS curve represents all the combination of income and the real interest rate such that the market for goods and services is in equilibrium.
e.
To explain: LM curve is upward slopping at the central bank’s policy choice of the interest rate.
e.
Answer to Problem 1QAP
False that the LM curve is not horizontal at the central bank’s policy choice of the interest rate.
Explanation of Solution
Increase in income leads to increase in demand for the money which further leads increase in the interest rate. Therefore, LM curve is upward slopping.
Introduction: LM curve represents the relationship the relationship between real output and interest rates.
f.
To explain: The real money supply is decreases along the LM curve.
f.
Answer to Problem 1QAP
False that the real money supply is not constant along the LM curve.
Explanation of Solution
As output will increase, demand for real money will increase and then central bank is required to increase the supply for real money to maintain the interest rate at constant level.
Introduction: LM curve represents the relationship between real output and interest rates.
g.
To explain: If the nominal money supply is $400 billion and the price level rises from an index value of 100 to an index value of 103; the real money supply rises.
g.
Answer to Problem 1QAP
False. If the nominal money supply is $400 billion and the price level rises from an index value of 100 to an index value of 103; the real money supply would not increase
Explanation of Solution
The real money supply decreases when the nominal money supply is constant and price level increases.
Introduction: LM curve represents the relationship the relationship between real output and interest rates.
h.
To explain: If the nominal money supply rises from $400 billion to $420 billion and the price level rises from an index value of 100 to 102, the real money supply rises.
h.
Answer to Problem 1QAP
True. If the nominal money supply rises from $400 billion to $420 billion and the price level rise from an index value of 100 to 102, the real money supply rises.
Explanation of Solution
The nominal money supply rise by 10% and price level rise by 2%, which will lead to increase in real money supply.
Introduction:LM curve represents the relationship the relationship between real output and interest rates.
i.
To explain: An increase in government spending leads to decrease in investment in the IS-LM model.
i.
Answer to Problem 1QAP
False. An increase in government spending does not lead to decrease in investment in IS-LM model
Explanation of Solution
An increase in government spending will increase the level of output and at the same level of interest rate; investment will increase in IS-LM model.
Introduction: IS-LM model describes equilibrium in both goods and financial markets.
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Chapter 5 Solutions
Macroeconomics, Student Value Edition Plus MyLab Economics with Pearson eText -- Access Card Package (7th Edition)
- Demand Supply Supply Demand LOANABLE FUNDS (Billions of dollars) Scenario 1: Individual Retirement Accounts (IRAS) allow people to shelter some of their income from taxation. Suppose the maximum annual contribution to such accounts is $5,000 per person. Now suppose there is an increase in the maximum contribution, from $5,000 to $8,000 per year. Shift the appropriate curve on the graph to reflect this change. This change in the tax treatment of saving causes the equilibrium interest rate in the market for loanable funds to and the level of investment spending to Scenario 2: An investment tax credit effectively lowers the tax bill of any firm that purchases new capital in the relevant time period. Suppose the government repeals a previously existing investment tax credit. Shift the appropriate curve on the graph to reflect this change. The repeal of the previously existing tax credit causes the interest rate to and the level of investment to Scenario 3: Initially, the government's…arrow_forward7. Consider the model where an individual has wealth k which they can either save or consume. If they save it, they receive a fixed and exogenous return r. The instantaneous utility function is given by: u(c, k) = c + a(k) where c is consumption, k is wealth, and a(k) is a function that defines the utility that an individual gets from holding wealth. The growth in wealth is given as the returns on wealth rk, plus income from working z(t), minus consumption c(t). a. Write out the differential equation for wealth. b. For an infinite time model, set up the optimal control problem with discounting at a rate 8. c. Write the current-valued Hamiltonian of this problem. d. Derive the steady-state level of consumption.arrow_forwardConsider the following information on aggregate income, consumption expenditure, and planned investment for a country:arrow_forward
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- QUESTION ONE Assume that an economy is represented by the following system of equation: C = C₁(Y-T) I = bo + b₂Yb₂i Ma P = C-a *i G = Go T = To Assume that a, bo, b₁,b₂, and c₁ are all positive and that b₁ + b₂ < 1. For simplicity assume that P = 1 Important: Note that unlike in the short run model we have saw in class, money demand depends on consumption, and not on total output. A. Derive an equation for the aggregate demand or the IS-curve in this closed economy and derive an expression for the slope of the IS as showing the relationship between interest rate and output B. Derive an equation for the LM curve and derive an expression for the slope of an LM curve and show the relation between interest rate and output C. Find an expression for equilibrium output and interest rates using answers in questions A and B.arrow_forwardYou are given the following data concerning Freedonia, a new republic. 1) Consumption is 200 when income is zero and the marginal propensity to consume is 0.6 out of every dollar increase in income 2) Investment function: I = 200 3) AE ≡ C + I 4) AE = Y Questions A. Derive the savings function? B. Graph equations 3) and 4) and solve for equilibrium income (Y). C. Suppose equation 2) is changed to I = 150. What is the new equilibrium level of income (Y)? By how much does the $50 decrease in planned investment change equilibrium income? What is the value of the tax multiplier?arrow_forwardProblem Set 4: Saving and Investment Economists in Fantasialand, a closed economy, have collected the following information about the economy for a particular year: Y = 9000; C = 6000; T = 1500; G = 1700. The economists also estimate that the investment function is: I = 3300 - 100r, where r is the country’s real interest rate, expressed as a percentage (i.e. r = 1 means interest rate is one percent). Calculate private saving, public saving, national saving, investment, and the equilibrium real interest rate.arrow_forward
