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Chapter Outline

PART IV MACROECONOMIC ANALYSIS. 12. Money, the Interest Rate, and Output: Analysis and Policy. Chapter Outline.

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Chapter Outline

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  1. PART IV MACROECONOMIC ANALYSIS 12 Money, the InterestRate, and Output:Analysis and Policy Chapter Outline The Links Between the Goods Market and the Money MarketInvestment, the Interest Rate, and the Goods MarketMoney Demand, Aggregate Output (Income), and the Money MarketCombining the Goods Market and the Money MarketExpansionary Policy EffectsContractionary Policy EffectsThe Macroeconomic Policy MixOther Determinants of Planned InvestmentLooking Ahead: The Price LevelAppendix: The IS-LM Diagram

  2. MONEY, THE INTEREST RATE, AND OUTPUT:ANALYSIS AND POLICY goods market The market in which goods and services are exchanged and in which the equilibrium level of aggregate output is determined. money market The market in which financial instruments are exchanged and in which the equilibrium level of the interest rate is determined.

  3. THE LINKS BETWEEN THE GOODS MARKETAND THE MONEY MARKET There are two key links between the goods market and the money market: ■ Link 1: Income and the Demand for Money Income, which is determined in the goods market, has considerable influence on the demand for money in the money market. ■ Link 2: Planned Investment Spending and the Interest Rate The interest rate, which is determined in the money market, has significant effects on planned investment in the goods market.

  4. An increase in output, all else the same, leads to: a. An increase in money demand. b. An increase in money supply. c. A decrease in the interest rate. d. An increase in both the supply and the demand for money.

  5. An increase in output, all else the same, leads to: a. An increase in money demand. b. An increase in money supply. c. A decrease in the interest rate. d. An increase in both the supply and the demand for money.

  6. THE LINKS BETWEEN THE GOODS MARKETAND THE MONEY MARKET FIGURE 12.1 Links Between the Goods Market and the Money Market

  7. THE LINKS BETWEEN THE GOODS MARKETAND THE MONEY MARKET INVESTMENT, THE INTEREST RATE, AND THE GOODS MARKET When the interest rate falls, planned investment rises. When the interest rate rises, planned investment falls. FIGURE 12.2 Planned Investment Schedule

  8. Reducing the interest rate, ceteris paribus, is likely to: a. Increase the level of planned investment spending. b. Decrease the level of planned investment. c. Shift the demand for money curve to the right. d. Shift the supply of money curve to the right.

  9. Reducing the interest rate, ceteris paribus, is likely to: a. Increase the level of planned investment spending. b. Decrease the level of planned investment. c. Shift the demand for money curve to the right. d. Shift the supply of money curve to the right.

  10. THE LINKS BETWEEN THE GOODS MARKETAND THE MONEY MARKET FIGURE 12.3 The Effect of an Interest Rate Increase on Planned Aggregate Expenditure

  11. THE LINKS BETWEEN THE GOODS MARKETAND THE MONEY MARKET The effects of a change in the interest rate include: ■ High interest rate (r) discourages planned investment (I). ■ Planned investment is a part of planned aggregate expenditure (AE). ■ Thus, when the interest rate rises, planned aggregate expenditure (AE) at every level of income falls. ■ Finally, a decrease in planned aggregate expenditure lowers equilibrium output (income) (Y) by a multiple of the initial decrease in planned investment. Using a convenient shorthand:

  12. When the interest rate rises, planned investment falls, and equilibrium output (income): a. Rises by exactly the same amount as the fall in planned investment. b. Rises by even more than the fall in planned investment. c. Falls by exactly the same amount as the fall in planned investment. d. Falls by even more than the fall in planned investment.

  13. When the interest rate rises, planned investment falls, and equilibrium output (income): a. Rises by exactly the same amount as the fall in planned investment. b. Rises by even more than the fall in planned investment. c. Falls by exactly the same amount as the fall in planned investment. d. Falls by even more than the fall in planned investment.

  14. THE LINKS BETWEEN THE GOODS MARKETAND THE MONEY MARKET MONEY DEMAND, AGGREGATE OUTPUT (INCOME), AND THE MONEY MARKET FIGURE 12.4 Equilibrium in the Money Market

  15. THE LINKS BETWEEN THE GOODS MARKETAND THE MONEY MARKET FIGURE 12.5 The Effect of an Increase in Income (Y) on the Interest Rate (r)

  16. THE LINKS BETWEEN THE GOODS MARKETAND THE MONEY MARKET The equilibrium level of the interest rate is not determined exclusively in the money market. Changes in aggregate output (income) (Y), which take place in the goods market, shift the money demand curve and cause changes in the interest rate. With a given quantity of money supplied, higher levels of Y will lead to higher equilibrium levels of r. Lower levels of Y will lead to lower equilibrium levels of r, as represented in the following symbols:

  17. For every possible level of the interest rate there is: a. Only one equilibrium level of Y. b. A different equilibrium level of Y. c. A possible equilibrium in the money market but never simultaneous with equilibrium in the money market. d. Always equilibrium in both the goods and money markets.

  18. For every possible level of the interest rate there is: a. Only one equilibrium level of Y. b. A different equilibrium level of Y. c. A possible equilibrium in the money market but never simultaneous with equilibrium in the money market. d. Always equilibrium in both the goods and money markets.

  19. COMBINING THE GOODS MARKETAND THE MONEY MARKET EXPANSIONARY POLICY EFFECTS expansionary fiscal policy An increase in government spending or a reduction in net taxes aimed at increasing aggregate output (income) (Y). expansionary monetary policy An increase in the money supply aimed at increasing aggregate output (income) (Y).

  20. COMBINING THE GOODS MARKETAND THE MONEY MARKET Expansionary Fiscal Policy: An Increase in Government Purchases (G) or a Decrease in Net Taxes (T) crowding-out effect The tendency for increases in government spending to cause reductions in private investment spending.

  21. COMBINING THE GOODS MARKETAND THE MONEY MARKET FIGURE 12.6 The Crowding-Out Effect

  22. Which multiplier effect is smaller? a. The multiplier of an increase in government spending. b. The multiplier of a decrease in net taxes. c. Neither multiplier above is smaller. The magnitude of a change in equilibrium GDP from either the multiplier of government spending or the multiplier of net taxes is identical. d. Any multiplier of autonomous expenditures other than the multiplier of G or T.

  23. Which multiplier effect is smaller? a. The multiplier of an increase in government spending. b. The multiplier of a decrease in net taxes. c. Neither multiplier above is smaller. The magnitude of a change in equilibrium GDP from either the multiplier of government spending or the multiplier of net taxes is identical. d. Any multiplier of autonomous expenditures other than the multiplier of G or T.

  24. COMBINING THE GOODS MARKETAND THE MONEY MARKET Effects of an expansionary fiscal policy: interest sensitivity or insensitivity of planned investment The responsiveness of planned investment spending to changes in the interest rate. Interest sensitivity means that planned investment spending changes a great deal in response to changes in the interest rate; interest insensitivity means little or no change in planned investment as a result of changes in the interest rate.

  25. COMBINING THE GOODS MARKETAND THE MONEY MARKET Effects of an expansionary monetary policy: Expansionary Monetary Policy: An Increase in the Money Supply

  26. Fed accommodation of an increase in government spending causes the multiplier of government spending to be: a. Larger. b. Smaller. c. Reduced to zero. d. Infinity.

  27. Fed accommodation of an increase in government spending causes the multiplier of government spending to be: a. Larger. b. Smaller. c. Reduced to zero. d. Infinity.

  28. COMBINING THE GOODS MARKETAND THE MONEY MARKET Expansionary Policy in Action: The Recessions of 1974–1975, 1980–1982, 1990–1991, and 2001 FIGURE 12.7 Fed Accommodation of an Expansionary Fiscal Policy

  29. COMBINING THE GOODS MARKETAND THE MONEY MARKET Effects of a contractionary fiscal policy: CONTRACTIONARY POLICY EFFECTS Contractionary Fiscal Policy: A Decrease in Government Spending (G) or an Increase in Net Taxes (T) contractionary fiscal policy A decrease in government spending or an increase in net taxes aimed at decreasing aggregate output (income) (Y).

  30. A decrease in net taxes results in: a. A decrease in Y, a decrease in r, and an increase in I. b. An increase in Y, an increase in r, and a decrease in I. c. An increase in Y, a decrease in r, and an increase in I. d. A decrease in Y, an increase in r, and a decrease in I.

  31. A decrease in net taxes results in: a. A decrease in Y, a decrease in r, and an increase in I. b. An increase in Y, an increase in r, and a decrease in I. c. An increase in Y, a decrease in r, and an increase in I. d. A decrease in Y, an increase in r, and a decrease in I.

  32. COMBINING THE GOODS MARKETAND THE MONEY MARKET Effects of a contractionary monetary policy: Contractionary Monetary Policy: A Decrease in the Money Supply contractionary monetary policy A decrease in the money supply aimed at decreasing aggregate output (income) (Y).

  33. COMBINING THE GOODS MARKETAND THE MONEY MARKET THE MACROECONOMIC POLICY MIX policy mix The combination of monetary and fiscal policies in use at a given time.

  34. Which policy mix favors investment spending over government spending? a. Expansionary fiscal policy and contractionary monetary policy. b. An increase in the money supply and a fall in government purchases. c. Both expansionary fiscal policy and expansionary monetary policy. d. None of the above. No policy mix favors investment over government spending.

  35. Which policy mix favors investment spending over government spending? a. Expansionary fiscal policy and contractionary monetary policy. b. An increase in the money supply and a fall in government purchases. c. Both expansionary fiscal policy and expansionary monetary policy. d. None of the above. No policy mix favors investment over government spending.

  36. OTHER DETERMINANTS OF PLANNED INVESTMENT The determinants of planned investment are ■ The interest rate ■ Expectations of future sales ■ Capital utilization rates ■ Relative capital and labor costs

  37. The demand for investment shifts to the right when: a. The interest rate decreases. b. Entrepreneurs are optimistic about future sales. c. Capital utilization rates are low. d. Labor is less expensive relative to capital.

  38. The demand for investment shifts to the right when: a. The interest rate decreases. b. Entrepreneurs are optimistic about future sales. c. Capital utilization rates are low. d. Labor is less expensive relative to capital.

  39. REVIEW TERMS AND CONCEPTS • contractionary fiscal policy • contractionary monetary policy • crowding-out effect • expansionary fiscal policy • expansionary monetary policy • goods market • interest sensitivity or insensitivity of planned investment • money market • policy mix

  40. Appendix A THE IS-LM DIAGRAM • AnIS curve illustrates the negative relationship between the equilibrium value of aggregate output (income) (Y) and the interest rate in the goods market. THE IS CURVE FIGURE 12A.1 The IS Curve

  41. Appendix A THE LM CURVE • An LM curve illustrates the positive relationship between the equilibrium value of the interest rate and aggregate output (income) (Y) in the money market. FIGURE 12A.2 The LM Curve

  42. Appendix A THE IS-LM DIAGRAM • The IS-LM diagramis a way of depicting graphically the determination of aggregate output (income) and the interest rate in the goods and money markets. FIGURE 12A.3 The IS-LM Diagram

  43. Appendix A FIGURE 12A.4 An Increase in Government Purchases (G)

  44. Appendix A FIGURE 12A.5 An Increase in the Money Supply (Ms)

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