REVIEW FOR EXAM #2

Note to Students: I will do everything possible to access e-mail while I’m away. However, if you need help, it is better to sit down with the Graduate Assistant and go over the problem.  If you e-mail him, he will be more than happy to schedule an appointment with you.  tymoignee@umkc.edu  In the meantime, focus on your homework and the review questions below.  If you do, there is no reason to expect anything but an "A"!

 

THE IS-LM MODEL

• Where does the IS/LM framework come from (i.e. who developed it)?
• What do all points along the IS curve have in common?
• Why is the IS curve drawn as downward-sloping?
• Why is the LM curve drawn as upward-sloping?
• What do all points along the LM curve have in common?
• Derive each curve. Be very careful.
• What causes the IS curve to shift out? (Give at least three examples)
• What can cause the IS curve to shift in? (Give at least three examples)
• What can cause the LM curve to shift out?
• What can cause LM to shift in?
• What determines the shape of each curve? (i.e. What kinds of things affect the slope of IS and LM?)  List them and then play with them.  For example, what happens when the multiplier increases?  (Note: a change in the multiplier requires a change in the MPC (and, implicitly, the MPS).  Be sure that you understand how the slopes of IS and LM are affected.  Play with the variables that underlie the slopes of IS and LM. Then draw new IS/LM curves to reflect the changes.  Careful—you will only be changing the slope of the curve.  Do not shift IS when, for example, the interest-elasticity of Investment Demand changes.
• In order for fiscal policy to be very powerful, what must the IS and LM curves look like? What conditions would give you these shapes?
• In order for monetary policy to be very effective, what must the IS and LM curves look like? What conditions would give you these shapes?
• Did Keynes favor the use of fiscal or monetary policy? Why?
• Can the LM curve become horizontal?  What would it take to get a horizontal LM? (Important!)
• Can the IS curve become vertical?  What would it take to get a vertical IS? (Important!)
• Can the “Keynes Effect” operate when the IS curve is vertical?
• Will monetary policy be effective when IS is vertical?
• Can fiscal policy be effective when the IS curve is vertical?
• What happens to GDP (i.e. Y) if liquidity preference changes when IS is vertical?
• If the LM curve becomes perfectly interest-elastic, what shape will the LM curve take?
• Does a perfectly elastic LM curve have anything to do with a liquidity trap?
• Can you have “crowding out” when the LM curve is horizontal?
• Which will be more powerful when LM is horizontal – fiscal or monetary policy?
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• What is special about the equilibrium that we get when we put the IS and LM curves together?
• Does it imply Y = Y_F?  Explain your answer.
• What kind of assumption can we make to ensure that the IS/LM model generates “Classical” results? 
• How does an exogenous increase in the price level affect the IS curve? The LM curve?  (Be careful! There is a trick here.)
• What is the ‘Keynes Effect’?  How does it operate?
• What is the ‘Pigou Effect’? How does it operate?