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**Economics 470/570Winter 2005Review Question Set for Week #7**

Definitions

IS curve

LM curve

Policy effectiveness

Crowding out

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**Short Answer**

1. Derive the LM curve graphically and explain intuitively why the LM curve slopes upward.

2. Explain why the LM curve is vertical when money demand is unaffected by changes in the interest rate (as in the classical model). More generally, explain why the LM curve is steeper when money demand is less sensitive to the interest rate.

3. Derive the IS curve graphically and explain intuitively why the IS curve slopes downward.

4. Explain why the IS curve is steeper when the sensitivity of investment to the interest rate falls.

5. When is investment more sensitive to changes in the interest rate, at full employment or in a recession? Explain.

6. When is money demand more sensitive to changes in the interest rate, at full employment or in a recession? Explain.

7. Is there any difference between using a tax cut to stimulate output rather than increasing government spending? Explain.

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**Essay**

1. What factors cause the LM curve to shift? In what direction do they shift the LM curve? Show the shifts graphically using money demand - money supply and LM curve diagrams.

2. Show graphically and explain intuitively how the slope of the LM curve
changes when the responsiveness of money demand to the interest rate (|L_{R}|)
increases.

3. What factors cause the IS curve to shift? In what direction do they shift the IS curve? Show the shifts graphically using 45 degree line and IS curve diagrams.

4. Show graphically and explain intuitively how the slope of the IS curve changes when the responsiveness of investment to the interest rate (|IR|) increases.

5. Consider points above or below the LM curve. Explain why there is excess demand or excess supply at each point and the forces that cause i to change so as to restore equilibrium. Next, consider points above or below the IS curve. Explain why there is excess demand or excess supply at each point and the forces that cause y to change so as to restore equilibrium. Use these results to explain why the IS-LM model is stable.

6. Show graphically and explain intuitively how an increase in (a) the money supply, and (b) government spending affects income and the interest rate in the IS-LM model.

7. Use the IS-LM model to examine how the relative effectiveness of monetary and fiscal policy changes as investment becomes less sensitive to the interest rate. Explain the result intuitively.

8. Use the IS-LM model to examine how the relative effectiveness of monetary and fiscal policy changes as money demand becomes less sensitive to the interest rate. Explain the result intuitively.