Question

True or false questions with justification. Evaluate carefully each of the following statements; decide if they are True or False and provide a precise justification for your answer. Your mark will depend on the quality of your response.

1. An increase in the marginal tax rate increases the investment multiplier, while an increase in the marginal propensity to consume lowers it.

2. If consumers become thrifty, in the sense that they reduce their autonomous consumption, for example, this will end up lowering their saving.

3. The IS curve is downward sloping because an increase in taxes lowers the level of output.

4. The demand for money does not depend on the interest rate because only bonds earn interest.

5. The central bank can annihilate the fall of the interest rate induced by an expansionary fiscal policy by decreasing the reserve ratio of private banks.

6. When the Central Bank implements and interest rate targeting policy, the LM curve becomes vertical as the money supply must be kept fixed to prevent the interest rate from changing.

Answer 1

Part 1) TRUE

Increse in tax would reduce the consumption demand and thus increase the investment multiplier. Increase in MPC would increase the consumption propensity thus reducing the multiplier.

Part 2) TRUE

The Paradox of Thrift states that with an increase in consumers thrift, it leads to reduced savings or at a level slightly lesser as before.

Part 3) FALSE

The IS curve slopes downward as the fall in interest rate increases investment hence increasing output

Part 4) FALSE

Value of opportunity cost for holding the money is the interest rate .

Part 5) FALSE

Lowering reserve ratio would further enable the expansionary policy creating a wider mobey supply in market and reduced interest rate in market.