Chapter 5, Problem 1QAP

a.

To determine

To explain:The main determinants of investment are the level of sales and the interest rate.

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.

Economics Concept Introduction

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 determine

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.

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.

Economics Concept Introduction

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 determine

To explain: The IS curve is downward sloping because goods market equilibrium.

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.

Economics Concept Introduction

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 determine

To explain: If government spending and taxes increase by the same amount, the IS curve does not shift.

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.

Economics Concept Introduction

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 determine

To explain: LM curve is upward slopping at the central bank’s policy choice of the interest rate.

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.

Economics Concept Introduction

Introduction: LM curve represents the relationship the relationship between real output and interest rates.

f.

To determine

To explain: The real money supply is decreases along the LM curve.

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.

Economics Concept Introduction

Introduction: LM curve represents the relationship between real output and interest rates.

g.

To determine

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.

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.

Economics Concept Introduction

Introduction: LM curve represents the relationship the relationship between real output and interest rates.

h.

To determine

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.

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.

Economics Concept Introduction

Introduction:LM curve represents the relationship the relationship between real output and interest rates.

i.

To determine

To explain: An increase in government spending leads to decrease in investment in the IS-LM model.

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.

Economics Concept Introduction

Introduction: IS-LM model describes equilibrium in both goods and financial markets.