Please explain whether the following are \"true\" \"false\" or \"uncertain\". a.
ID: 1134941 • Letter: P
Question
Please explain whether the following are "true" "false" or "uncertain".
a. The main determinants of investment are the level of sales and the interest rate.
b. If all the exogenous variables in the IS relation are constant, then a higher level of output can be achieved only by lowering the interest rate.
c. The IS curve is downward sloping because goods market equilibrium implies that an increase in taxes leads to a lower level of output.
d. If government spending and taxes increase by the same amount, the IS curve does not shift.
e. The LM curve is horizontal at the central bank’s policy choice of the interest rate.
f. The real money supply is constant along the LM curve.
g. If the nominal money supply is $400 billion and the price level rises from an index value of 100 to an index value of 103; the real money supply rises.
h. If the nominal money supply rises from $400 billion to $420 billion and the price level rises from an index value of 100 to 102, the real money supply rises.
i. An increase in government spending leads to a decrease in investment in the IS-LM model.
Explanation / Answer
A. True.
There are two types of investment:- Private investment and government investment. The government investment is otherwise known as autonomous investment. The government investment is not depending on the level of return. But the private investment is determined by the level of return. That is why the private investment is known as induced investment. While making investment the private persons have to pay interest on borrowed fund. If the return from investment is greater than the interest the person pay for borrowed fund will make more investment. The return (MEC) depends upon the level of sales. Hence interest rate and sales are the main determinants of investment.
B. True
The level of investment is determined by the exogenous factors such as business expectations, excess capacity, level of income, consumer demand, inventions and innovations and growth of populations etc. While interest rate remains the same any change in any of these factors change the level of investment and the IS function. If these variables are constant a fall in rate of interest is necessary to make further investment and higher output.
C . True
The IS curve shows the relation between the rate of return and the level of investment. At a higher level of return, investment will be high and viceversa. A higher tax reduces the return from investment. Likewise a lower tax increases the return. A lower tax implies higher return and higher tax yields lower return. Like the rate of interest and investment the tax rate and the level of investment related inversely. Thus IS curve is downwards sloping as higher tax leads to lower investment and output.
D. True
While the government spending increases the income of the people, it will be offset by the increase in taxes. The IS curve shift forward due to increase in consumption (C), Investment (I), Government purchase (G) and Export (X-M). The increase in government spending increase the income of the people. But the increase in tax reduce the increased income of the people. The increase in income and fall in income are equal. Hence the IS curve does not shift.
E. False.
While the IS curve is the downward sloping curve, LM curve is an upward sloping curve. At a higher rate of interest the central bank’s choice is to increase the money supply to reduce the interest rate. Then the LM curve shift to the right with fall in rate of interest. On the other hand during time of low interest rate, the central bank’s choice is to reduce the money supply and increase the rate of interest. Then the LM curve shift to the left leading contraction in money supply and high interest rate.
F. False
The real money supply is not constant. It changes with the central bank’s policy decisions and the demand for money of the people.
G. False.
The nominal money supply is the money supply in money terms. The real money supply is the supply of money in terms of good at services. It is the purchasing power of nominal money supply. The real money supply increase only when in increase in nominal money supply provided that the price level remaining the same. Here the price index increase along with the increase in nominal money supply and therefore real money supply does not increase. Actually the increase in price level reduces the real money supply.
H. False
The increase in money supply along with the increase in price level does not increase the real money supply. The real money supply will be constant.
I . False.
The government spending consists of investment in infrastructure and other productive channel. The increase in government spending is and increases in investment in IS-LM model. It increases the investment in government level and also induce the private investment.