**Definitions**

Consumption, disposable income, MPC and MPS

Investment

Government spending

Aggregate demand or expenditures

Expenditure multiplier

IS curve

LM curve

Policy effectiveness

Crowding out

Potential or natural rate of output

Short-run aggregate supply

Long-run aggregate supply

Debt monetization

Inflation

Cost push inflation

Demand pull inflation

Activist/non-activist

Data lag

Recognition lag

Legislative lag

Implementation lag

Effectiveness lag

Policy ineffectiveness proposition

Rational expectations

Price rigidity

Essay

Chapter 19 [cont.]

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

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

3. Derive the IS curve. Explain intuitively why it slopes downward. What factors cause the IS curve to shift? In what direction do they shift the IS curve?

4. Derive the LM curve. Explain intuitively why it slopes upward. What factors cause the LM curve to shift? In what direction do they shift the LM curve?

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

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

7. Explain why the LM curve is vertical when money demand is unaffected by changes in the interest rate (as in the classical model). Explain and show graphically why the LM curve is horizontal in a liquidity trap.

8. 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 (examine the cases where the LM curve is either vertical or horizontal). Explain the result intuitively. What does this imply about the use of monetary and fiscal policy over the business cycle?

9. 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.

10. 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 (examine the cases where the IS curve is either vertical or horizontal). Explain the result intuitively. What does this imply about the use of monetary and fiscal policy over the business cycle?

11. Show that the Fed cannot continuously hit both a money supply target and an interest rate target, i.e. that it must choose one or the other.

12. Explain Poole's rules.

13. Do changes in the money supply and government spending affect output in the long-run? Explain using the IS-LM model.

14. Derive the aggregate demand curve from the IS-LM model and explain intuitively why it slopes downward. What factors cause the AD curve to shift? In what direction do they shift the AD curve?

15. Why does the short-run aggregate supply curve slope upward? What factors cause the aggregate supply curve to shift?

16. Is the economy self-correcting? What problems are encountered in the pursuit of activist policies?

17. What causes the LRAS curve to shift, i.e. what factors affect the natural rate of output? Explain.

18. (a) Do Monetarists agree with Friedman's contention that inflation is always and everywhere a monetary phenomenon? Explain using the AD-AS model. (b) Do Keynesians agree with Friedman's contention that inflation is always and everywhere a monetary phenomenon? Explain using the AD-AS model.

19. Explain how the pursuit of a high employment target by policymakers can lead to inflation.

20. Can budget deficits lead to inflation? Explain.

21. Why might governments choose to monetize the debt?

22. Compare and contrast the effects of an unexpected increase or decrease in the money supply on prices and output in the traditional Keynesian, New Classical, and New Keynesian models.

23. Compare and contrast the effects of an expected increase or decrease in the money supply on prices and output in the traditional Keynesian, New Classical, and New Keynesian models.

24. Suppose the monetary authority wants to stop inflation rate. Compare the costs (in terms of output) of reducing inflation in the traditional Keynesian, New Classical, and New Keynesian models. Be sure to cover both an expected and an unexpected change in policy. Why is the credibility of policymakers important?