Intermediate Macroeconomics

Spring 2013

Sample Question Set #4

Orthodox Keynesianism: IS-LM Model

1. What are the four distinguishing beliefs of Orthodox Keynesianism?

2. What do I, S, L, and M represent in the IS-LM model? What does the IS curve represent? What does the LM curve represent?

3. Derive the IS curve from the Keynesian-cross expenditures model. What components are held constant along a given IS curve? Upon what does the slope of the IS curve depend? How much will the IS curve shift for a given change in government expenditures?

4. Derive the LM curve from the money market model. What components are held constant along a given LM curve? Upon what does the slope of the LM curve depend? How much will the LM curve shift for a given change in the money supply?

5. Discuss the notion of “the liquidity trap.” If a liquidity trap exists, what does this imply about the shape of the LM curve?

6. What does the intersection of the IS and LM curves portray? Under what circumstances is fiscal policy more robust than monetary policy? Under what circumstances is monetary policy more robust than fiscal policy?

7. Show how rigid money wages and interest rates contribute to an underemployment equilibrium in the IS-LM model.

8. Under what circumstances will an economy, even with flexible wages and prices, fail to achieve full employment equilibrium within the IS-LM model? Show each case.

9. What is the Pigou effect? If the Pigou effect is operational, will interest-inelastic investment or the existence of a liquidity trap prevent the economy from reaching full employment equilibrium? Show within the IS-LM model. What criticisms have been made concerning the existence and effectiveness of the Pigou effect?

Orthodox Keynesianism: Open Economy IS-LM and the Phillips Curve

1. What do economists mean by the distinction between an open and closed economy? Why did open economy models become more important in the late 1950s?

2. What two economists developed the open economy IS-LM model? What are the two additional elements of AD in an open economy model and what are the independent variables that impact their magnitude?

3. Distinguish between a fixed exchange rate and flexible exchange rate regime. What is the balance of payments? What are the two primary accounts in the balance of payments and how are they related?

4. What is the BP curve? Why is it positively sloped? What does the slope depend upon? What is the balance of payments for points off the curve? Above? Below? If the BP curve is perfectly elastic what does that tell us about capital mobility? Perfectly inelastic?

5. What will cause the BP curve to shift? Note the relationship between BP curve shifts and independent variable changes.

6. Why is the LM curve typically steeper than the BP curve? If the LM curve is steeper than the BP curve, is monetary policy or fiscal policy more effective under a fixed exchange rate system? Under a flexible exchange rate system?

7. What is the Phillips Curve? What is the argument for the inverse relationship between the rate of change of money wages and unemployment?

8. What was the importance of the Phillips Curve for orthodox Keynesianism in the late 1950s and early 1960s, i.e., why were Keynesians so quick to adopt the Phillips curve into their models and policies?

9. What are the 9 central propositions of Orthodox IS-LM Keynesianism.