Question

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

1 - False

The increase in the value of MPC will increase the value of multiplier and not reduce it

2 - False

The decrease in the tendency to consume will result in the increase in savings and not decrease.

3 - False

The dowmward slope of IS curve is due to the inverse relation between the interest rates and the amout of investment

4 - False

There is direct relationship between the demand for money and the interest rates.

5 - False

The annihilation of the falling interest rates will be caused by contractionary policy and not the expansionary policy such as decrease in reserve rate.

6 - False

The vertical LM curve represents that the GDP will not change , as the result of interest rates. Hence GDP is constant and not the interest rates.