Question

1- In Keynes’s underemployment model with fixed money wages, if there is an exogenous fall in investment, the economy will settle at a lower price level leading to  

a- a shift in the LM curve to the right and real wage to rise.

b- a shift in the LM curve to the left and real wage to fall.

c- a shift in the LM curve to the left and real wage to rise.

d- a shift in the LM curve to the right and real wage to fall.

2-In Keynes’s model, the existence of liquidity trap means that the AD curve is vertical at a level of output below full employment because

a- a rise in the price level which increases the real money supply has real effect on output.

b- a rise in the price which decreases the real money supply has no real effect on output.

c- a fall in the price level which increases the real money supply has no real effect on output.

d- a fall in the price level which decreases the real money supply has real effect on output.

3- Which of the following statements is not TRUE of Keynes’s model?

a- Output and employment are determined in the goods market.

b-Monetary policy can have real effects.

c-An increase in government expenditure results in an equivalent fall in private investment.

d-All statements are TRUE of Keynes’s model

e-b and c are not TRUE

4- Which of the following statements is TRUE regarding the determinants of the slope and position of the IS curve?

a-The smaller the interest-sensitivity of investment, the flatter the IS curve.

b- A fall in the MPC rotates the IS curve clock-wise making it steeper.

c- A rise in government expenditure will the IS curve to shift the right.

d- All statements are TRUE.

e- b and c are TRUE.   

Answer 1

1) a is correct

LM curve is M/P. Fall in P ( price) increases the real money balances which shifts the LM to the right. Real wage= w/P , w is fixed and P falls which increases real wage.

2) c is correct

Liquidity trap is a situation when increase in money supply had no effect on investment spending because interest rate cannot fall any below.

3) a is correct

Demand for labour depends on demand for goods. Therefore we can say output and employment are determined in good market.

4) c is correct

Increase in government expenditure shifts the IS curve to the right.