Economics 330

Fall 2001

Study Questions

1. What does Keynes assume about price levels in his model? In equilibrium, what must be true for his model?

2. Does Keynes allow for inflation in his model? Does this, in your estimation, limit the usefulness of his model? Why or why not?

3. Is full employment always attained in the Keynesian model? Why or why not? What does Keynes recommend if the economy in equilibrium is at an output less than the full employment level of output? Can the economy produce an output greater than the full employment level of output? Is this possible in the short run and not the long run? Comment on this possibility.

4. What is disposable income? What does the mpc measure? How do you interpret the mpc? Is the mpc a constant over time? What determines the mpc? What is autonomous consumption? If your income is zero, will there still be autonomous consumption? Why or why not? What does the y-intercept of the consumption function measure? With respect to a graph of the consumption function, where is the mpc?

5. What is fixed investment and what is inventory investment? Are both of these planned investment? Why or why not? What factors influence planned investment spending? What is planned investment spending?

6. What doe we mean by the term equilibrium in the Keynesian model? What is a Keynesian cross diagram? What does the 45 degree line in the Keynesian cross diagram signify? What is the aggregate demand function? How do you determine an aggregate demand function from a consumption function and an investment function? Can you make up some examples of consumption and investment functions and derive the aggregate demand function? Can you solve this for equilibrium?

7. Does the Keynesian model tend toward equilibrium? Why or why not? What happens to this model if the equilibrium level of output is below the full employment level? What happens if the equilibrium level of output is greater than the full employment level of output? Use graphs to illustrate what is happening in both of these situations.

8. What is an expenditure multiplier? Can you solve a series of equations and find the expenditure multiplier?

9. What determines the level of autonomous spending according to Keynes? What is autonomous spending? What did Keynes mean by “animal spirits”?

10. What happens to the consumption function when you add in taxes and government spending in the Keynesian model? Is an increase in taxes considered expansionary or contractionary in the Keynesian model? Justify your answer.

11. Summarize what factors shift the aggregate demand function. Do you understand the mathematical relationships underlying these factors? How does the government expenditure multiplier differ from the tax expenditure multiplier? Derive the difference mathematically.

12. The Keynesian model looks only at goods market equilibrium. Agree or disagree.

13. If the consumption function is C = 100 + .8Y and planned investment spending is 200, what is the equilibrium level of output? If planned investment falls by 100, how much does the level of output fall?

14. If business firms suddenly become more optimistic about the profitability of investment so that planned investment spending rises by $100 billion, while consumers become more pessimistic so that autonomous consumer spending falls by $100 billion, what happens to aggregate output?

15. If the consumption function is C = 100 = .75Y, I = 200, and government spending is 200, what will be the equilibrium level of output? Demonstrate your answer with a Keynesian cross diagram. What happens to aggregate output if government spending rises by 100?

16. What is the IS curve? What factors determine the IS curve? How does the IS curve respond when these factors change? What area corresponds to an excess supply of goods in an IS graph?

17. What is the LM Curve? What factors determine the LM curve? How does the LM curve respond when these factors change? What area corresponds to excess demand for money in a LM graph?

18. Does the ISLM model tend toward equilibrium? Justify your answer.

19. How does monetary policy affect the ISLM model? How does fiscal policy affect the ISLM model? Under what conditions is fiscal policy ineffective in the ISLM model? How does the interest sensitivity of money demand affect the effectiveness of monetary policy in this model?

20. If the LM curve is stable and the IS curve is relatively unstable, what kind of target should the Fed pursue with regard to monetary policy? Is this a situation that supports the Keynesian viewpoint or the monetarist viewpoint?

21. If the IS curve is stable and the LM curve is relatively unstable, what kind of target should the Fed pursue with regard to monetary policy? Is this a situation that supports the Keynesian viewpoint or the monetarist viewpoint?

22. What is an AD curve? What factors shift the AD curve? What is the relationship between these factors and the AD curve? How is the AD curve related to the IS and the LM curves?

23. How does the AD curve shift if there is a shift in the IS curve? How does the AD curve shift if there is a shift in the LM curve?

24. How does the monetarist perspective on the AD curve differ from the Keynesian perspective?

25. What factors shift the AS curve? What is the difference between the short run AS curve and the long run AS curve?

26. What does equilibrium in the AD/AS model mean in the short run? What does equilibrium in the AD/AS model mean in the long run? Describe the adjustment process from a short run equilibrium to a long run equilibrium. What is the natural rate of unemployment? How is the natural rate of unemployment related to the full employment level of output?