Question

2 Answer True or False. Briefly explain your answer. No credit without explanation. Support your answers with a graph. [35 points]

1. (a) Answer if the following statement is true or false: “Negative IS shocks (e.g., an exogenous decrease in consumption) and negative LM shocks (e.g., an exogenous increase in the demand for money) shift the aggregate demand curve downward.” Use a graph of the Aggregate Demand and a graph of the IS-LM model to support your answer. [11 points]

2. (b) Answer if the following statement is true or false: “A decrease in government spending (G) reduces output more in the Keynesian-cross model than in the IS-LM model.” Use a graph of the Keynesian Cross and a graph of the IS-LM model to support your answer. [12 points]

3. (c) Suppose the level of output in Country A is currently equal to Y1. For political reasons the government of Country A decides to cut taxes in order to increase the level of economic activity and income such that Y2 > Y1(may be to get more votes in the next election). The Central Bank in Country A concludes that the level of income Y1 is closer to the efficient level (or potential output) and for that reason it feels that a higher level ofY is not what the economy needs at that time. Answer if the following statement is true or false: “After the reduction in Taxes, the Central Bank in Country A needs to reduce the money supply in order to keep the level of output (Y) constant at the initial level Y1.” Use a graph of the closed economy IS-LM model to support your answer. [12 points]

Answer 1