**Definitions**

Quantity equation

Velocity of money

Equation of exchange

Consumption, disposable income, MPC and MPS

Investment

Government spending

Aggregate demand or expenditures

Autonomous expenditures

Expenditure multiplier

Autonomous money demand

IS curve

LM curve

Policy effectiveness

Crowding out

**Essay**

1. Explain the quantity theory of money. Explain the Cambridge approach and illustrate that it leads to the same identity as the quantity theory. What assumptions are imposed to arrive at a theoretical statement?

2. Is velocity a constant in Keynes liquidity preference theory? When actual data is examined, does velocity appear to be a constant? Why is this important?

3. What is the money demand function in the classical model?

4. Discuss the transactions, precautionary, and speculative motives for holding money in Keynes liquidity preference theory. When all three motives are put together, what theory of money demand emerges?

5. Show the money demand curve graphically. Show how the money demand curve shifts when income increases.

6. According to Baumol, the transactions demand for money depends upon the interest rate as well as nominal income. Explain why the transactions demand for money depends upon the interest rate. Why is this important?

7. What did Tobin add to Keynes theory of the speculative demand for money? Why was this development important?

8. Explain Friedman's Modern Quantity Theory of the Demand for Money.

9. What is the 45 degree line diagram? What is the expenditure multiplier?

10. What is the slope of the expenditure function? What factors cause the expenditure function to shift?

11. Derive the IS curve. Explain intuitively why it slopes downward.

12. Derive the LM curve. Explain intuitively why it slopes upward.

13. What factors cause the IS curve to shift? In what direction do they shift the IS curve?

14. What factors cause the LM curve to shift? In what direction do they shift the LM curve?

15. Show graphically and explain intuitively how an increase in government spending affects income and the interest rate in the IS-LM model.

16. Show graphically and explain intuitively how an increase in the money supply affects income and the interest rate in the IS-LM model.

17. Explain why the LM curve is vertical when money demand is unaffected by changes in the interest rate (as in the classical model).

18. Use the IS-LM model to show that monetary policy becomes more effective
relative to fiscal policy as money demand becomes less sensitive to the interest
rate. Explain the result intuitively.

19. Explain why investment is less sensitive to interest rate changes in recessions as compared to when the economy is operating closer to full employment. Explain why the IS curve is vertical when investment is completely insensitive to changes in the interest rate.

20. Use the IS-LM model to show that fiscal policy becomes more effective relative to monetary policy as investment becomes less sensitive to the interest rate. Explain the result intuitively. What does this imply about the use of monetary and fiscal policy over the business cycle?