Question

1..Expansionary fiscal policy ............... equilibrium output and ...................... the interest rate if the Central Bank keeps the money supply constant.

Select one:

a. raises----raises

b. raises---falls

c. falls---raises

d. falls---falls

2.The less interest-sensitive money demand is, the more effective monetary policy is relative to fiscal policy.

Select one:

True?

False?

3.Which of the following is not cause the LM curve to shift right?  

Select one:

a. fall in the money demand

b. all of the above

c. fall in the money supply

d. rise in the money supply

4. The aggregate price level is measured as the rate of change in the inflation rate.

Select one:

True?

False?

Answer 1

Ques 1.

An expansionary fiscal policy takes place when the government cuts taxes or increases government spending or a mix of both.

In such a case, the aggregate demand curve shifts rightwards, intersecting the old aggregate supply curve at a higher point with a higher equilibrium price level and increased output.

As a result of an increase in prices, the real money supply in the economy falls, resulting in an increase in interest rate, unless countered by an increase in the money supply.

Thus, Expansionary fiscal policy ...raises.... equilibrium output and .....raises.... the interest rate if the Central Bank keeps the money supply constant.

Ans. (A)

Ques 2.

When interest responsiveness of the demand for money is less i.e. when the LM is steeper, a given increase in government expenditure will have a large crowding-out effect. Thus, an expansionary or contractionary fiscal policy will not be effective in such a case.

A monetary policy, however, will shift the LM curve and will thus be more effective.

Ans. (A) True

Ques 3.

Shifts in the LM curve i.e. the money-market curve is caused either due to changes in the money demand or money supply.

A rightward shift in the LM curve is caused when the money supply in the economy increases, resulting in a lower interest rate at each level of output.

Ans. (D)

Ques 4.

Inflation is defined as the overall increase in the price level in the economy i.e. by definition, it is the rate of change of aggregate price level.

Ans. (A) True