Practice Questions
proposed as preparation for the second midterm exam
by Vitaliy
1. Using IS-LM graph illustrate the effect of reduction in the price level
on output. Explain the effect of decrease in P on M, M/P, i and I.
2. True/False/Uncertain
a. The aggregate supply relation implies that an increase in output
leads to an increase in the price level.
b. The natural level of output can be determined by looking only
at the aggregate supply relation.
c. The aggregate demand relation implies that an increase in the
price level leads to an increase in output.
d. In the absence of changes in fiscal and/or monetary policy, the
economy will always remain at the natural level of output.
e. Expansionary monetary policy has no effect on the level of
output in the medium run.
f. Fiscal policy cannot affect investment in the medium run,
because output always returns to its natural level.
g. In the medium run, prices and output always return to the same
value.
3. Explain what effect each of the following events has on the IS curve,
the LM curve and AD curve.
a. Increase in G.
b. Decrease in M.
c. Rise in consumer confidence.
d. Increase in T.
e. Increase in P.
4. Suppose the economy is initially operating at Yn. Now suppose the
Fed conducts a monetary contraction where the nominal money
supply falls.
a. Use the AS-AD graph to illustrate the initial equilibrium,
dynamic adjustment and medium-run equilibrium.
b. What are the initial effects of the drop in M on P, M/P, i, I, and
Y?
c. What happens to u and Y relative to their natural levels during:
the short run, the dynamic adjustment, and the medium run?
d. When Y is less than Yn, what happens to the AS curve for the
next year? Explain.
e. As the AS curve shifts, what happens to P, M/P, i, I, and Y?
f. What are the medium-run effects of the drop in M on P, M/P, i,
I, and Y?
g. Does Y return to Yn? If so, what does this suggest about P and
Pe in the medium run?
h. Suppose M fell by 6%. How much did P and Pe fall in the
medium run?
i. Did the drop in M have any medium-run effects on real
variables (i, Y, I)?
j. What are the medium-run effects of drop in M on the nominal
and real wages?
5. Using the AS-AD model, show the effects of each of the following
shocks on the position of the IS, LM, AD and AS curves in the
medium run. Then show the effect on output, the interest rate, and the
price level, also in the medium run. Assume that before the changes,
the economy was at the natural level of output.
a. An increase in consumer confidence.
b. An increase in taxes.
6. Using the As-AD model, show the effects of each of the following
shocks on the position of the WS, PS, IS, LM, AD and AS curves in
the medium run. Then state the effects on output, the interest rate, and
the price level, also in the medium run. Assume that before the
changes, the economy was at the natural level of output.
a. An increase in unemployment benefits.
b. A decrease in the price of oil.
Enjoy !!!
2
Answers will be provided in the review session on 04/16/2002, by Vitaliy.
3