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Module M14 Quiz: The IS-LM Model Part I

25 questions · Intermediate · Mix of multiple choice, calculation, and short answer

How to use

Attempt each question before clicking Show Answer. For calculation questions, write out your working before checking.

Question 1

Lesson L01 · Monetary Policy

What primarily causes the IS curve to slope downward?

Type: Multiple Choice

  • A) Lower interest rates increase consumption directly
  • B) Higher interest rates reduce investment, lowering equilibrium output
  • C) Higher output reduces money demand
  • D) Lower output increases government spending
Show Answer

Answer: B) Higher interest rates reduce investment, lowering equilibrium output

The IS curve slopes down because higher interest rates reduce investment, which lowers equilibrium output via the multiplier.

Question 2

Lesson L01 · Fiscal Policy

Which of these would shift the IS curve to the right?

Type: Multiple Choice

  • A) Increase in taxes
  • B) Decrease in government spending
  • C) Increase in exports
  • D) Increase in interest rates
Show Answer

Answer: C) Increase in exports

Higher exports increase autonomous spending (A), shifting IS right.

Question 3

Lesson L01 · Monetary Policy

Calculate equilibrium Y when i=5% A=700 b_inv=500 b=0.8 m=0.1

Type: Calculation

Show Answer

Answer: 2267

Y = (700 - 500×0.05)/0.3 = 675/0.3 = 2,267

Question 4

Lesson L01 · Monetary Policy

Explain why lower interest rates increase output in the IS framework.

Type: Short Answer

Show Answer

Answer: Lower rates boost investment which increases autonomous spending and equilibrium output via the multiplier.

The investment channel drives the IS curve negative slope.

Question 5

Lesson L01 · Fiscal Policy

If MPC rises from 0.8 to 0.9 the IS curve becomes:

Type: Multiple Choice

  • A) Steeper
  • B) Flatter
  • C) Shifts right
  • D) Shifts left
Show Answer

Answer: A) Steeper

Higher MPC increases (1-b+m)/b_inv making IS steeper.

Question 6

Lesson L02 · Monetary Policy

What two components make up Keynesian money demand?

Type: Multiple Choice

  • A) Transaction and precautionary
  • B) Transaction and speculative
  • C) Savings and investment
  • D) Currency and deposits
Show Answer

Answer: B) Transaction and speculative

L = kY (transactions) - hi (speculative)

Question 7

Lesson L02 · Monetary Policy

If income rises while money supply is fixed the interest rate:

Type: Multiple Choice

  • A) Falls
  • B) Rises
  • C) Stays same
  • D) Becomes negative
Show Answer

Answer: B) Rises

Higher Y increases transaction demand requiring higher i to restore equilibrium.

Question 8

Lesson L02 · Monetary Policy

Calculate i when Y=2400 k=0.25 h=5000 M=500 P=1

Type: Calculation

Show Answer

Answer: 0.02

i = (0.25×2400 - 500)/5000 = 100/5000 = 0.02

Question 9

Lesson L02 · Monetary Policy

Why does money demand depend negatively on interest rates?

Type: Short Answer

Show Answer

Answer: Higher rates make bonds more attractive reducing speculative demand for money.

The opportunity cost of holding money rises with interest rates.

Question 10

Lesson L02 · Monetary Policy

In a liquidity trap money demand becomes:

Type: Multiple Choice

  • A) Perfectly interest-inelastic
  • B) Perfectly interest-elastic
  • C) Unaffected by income
  • D) Negative
Show Answer

Answer: B) Perfectly interest-elastic

Near ZLB h→∞ making LM horizontal.

Question 11

Lesson L03 · Monetary Policy

The LM curve slopes upward because:

Type: Multiple Choice

  • A) Higher output requires higher investment
  • B) Higher income increases money demand raising equilibrium interest rates
  • C) The central bank targets higher rates when output rises
  • D) Higher rates attract foreign capital
Show Answer

Answer: B) Higher income increases money demand raising equilibrium interest rates

Transaction demand rises with Y requiring higher i to clear money market.

Question 12

Lesson L03 · Monetary Policy

An open market purchase of bonds by the RBA would:

Type: Multiple Choice

  • A) Shift LM left
  • B) Shift LM right
  • C) Move economy along LM
  • D) Have no effect
Show Answer

Answer: B) Shift LM right

Increases money supply shifting LM right.

Question 13

Lesson L03 · Monetary Policy

Find Y when i=3% k=0.25 h=5000 M=500 P=1

Type: Calculation

Show Answer

Answer: 2600

0.03 = 0.00005Y - 0.1 → Y = 0.13/0.00005 = 2600

Question 14

Lesson L03 · Monetary Policy

What happens to LM slope if money demand becomes more interest-sensitive?

Type: Short Answer

Show Answer

Answer: LM becomes flatter (h increases reducing slope k/h).

Higher h makes money demand more responsive to interest rate changes.

Question 15

Lesson L03 · Monetary Policy

In the classical case (h→0) the LM curve becomes:

Type: Multiple Choice

  • A) Horizontal
  • B) Vertical
  • C) Upward sloping
  • D) Downward sloping
Show Answer

Answer: B) Vertical

As h→0 LM becomes vertical (only one Y clears money market).

Question 16

Lesson L04 · Monetary Policy

IS-LM equilibrium occurs when:

Type: Multiple Choice

  • A) Goods market clears
  • B) Money market clears
  • C) Both goods and money markets clear
  • D) Investment equals savings
Show Answer

Answer: C) Both goods and money markets clear

Both markets must simultaneously clear at (Y i).

Question 17

Lesson L04 · Fiscal Policy

A fiscal expansion in IS-LM framework:

Type: Multiple Choice

  • A) Shifts IS right raising both Y and i
  • B) Shifts LM left lowering Y*
  • C) Moves along IS curve
  • D) Has no effect on output
Show Answer

Answer: A) Shifts IS right raising both Y and i

Higher G increases A shifting IS right; higher Y raises money demand increasing i*.

Question 18

Lesson L04 · Monetary Policy

Solve for Y* when IS: i=1.4-0.0006Y and LM: i=0.00005Y-0.1

Type: Calculation

Show Answer

Answer: 2308

1.4-0.0006Y=0.00005Y-0.1 → 1.5=0.00065Y → Y=2308

Question 19

Lesson L04 · Monetary Policy

Why can't IS alone determine Y* without LM?

Type: Short Answer

Show Answer

Answer: Because investment depends on i which is determined by money market equilibrium.

Both markets interact - goods market needs i from money market.

Question 20

Lesson L04 · Monetary Policy

In a liquidity trap monetary policy becomes:

Type: Multiple Choice

  • A) More effective
  • B) Ineffective
  • C) Changes LM slope
  • D) Only affects inflation
Show Answer

Answer: B) Ineffective

Near ZLB LM is horizontal so money supply changes don't affect i or Y.

Question 21

Lesson L05 · Fiscal Policy

What happens to output and interest rates when IS shifts right?

Type: Multiple Choice

  • A) Both increase
  • B) Both decrease
  • C) Output increases, interest decreases
  • D) Output decreases, interest increases
Show Answer

Answer: A) Both increase

Rightward IS shift increases output, which raises money demand and interest rates

Question 22

Lesson L05 · Monetary Policy

Which shock would shift LM left?

Type: Multiple Choice

  • A) Money supply increase
  • B) Price level decrease
  • C) Price level increase
  • D) Tax cut
Show Answer

Answer: C) Price level increase

Higher price level reduces real money supply, shifting LM left

Question 23

Lesson L05 · National Accounts

Calculate new Y* when IS: Y=2000-100r and LM: Y=1000+100r

Type: Calculation

Show Answer

Answer: 1500

Set 2000-100r=1000+100r → r=5 → Y=2000-100(5)=1500

Question 24

Lesson L05 · Intermediate

Define partial crowding out

Type: Short Answer

Show Answer

Answer: When fiscal expansion raises interest rates, reducing private investment

fiscal-policy

Question 25

Lesson L05 · Fiscal Policy

What determines crowding out magnitude?

Type: Multiple Choice

  • A) LM slope only
  • B) IS slope only
  • C) Both IS and LM slopes
  • D) Neither
Show Answer

Answer: C) Both IS and LM slopes

Steeper LM or flatter IS increases crowding out