Economics - Economics Section 1
51. Which of the following best describes the relationship depicted by the LM curve?
- Option : A
- Explanation : The LM curve shows an upward sloping relationship between i and Y. The increase in income causes the demand for money to increase. However, the money supply is unaffected by the increase in income. The only way that money demand and money supply can be equal again is if interest rates also increase to reduce money demand.
52. Which of the following best describes the relationship shown by the AD curve?
- Option : B
- Explanation : The AD curve depicts an inverse relationship between the price level and real income/output. When price level decreases, the quantity of goods and services demanded increases.
53. A decrease in government spending would most likely shift the:
- Option : B
- Explanation : The IS curve represents the combinations of income and the real interest rate at which planned expenditure equals income. Equivalently, it represents combinations such that S (Y) = I (r) + (G – T) + (X – M), where S (Y) indicates that planned saving is a (increasing) function of income and I (r) indicates that planned investment is a (decreasing) function of the real interest rate.
54. A decrease in the nominal money supply would most likely shift the:
- Option : C
- Explanation : The LM curve represents the combinations of income and the interest rate at which the demand for real money balances equals the supply. For a given price level, a decrease in the nominal money supply is also a decrease in the real money supply. To decrease the demand for real money balances, either the interest must rise or income must decrease. Therefore, at each level of the interest rate, income (= expenditure) must decrease—a leftward shift of the LM curve. Since the IS curve is downward sloping (higher income requires a lower interest rate), a leftward shift in the LM curve means that the IS and LM curves will intersect at a lower level of aggregate expenditure/income. This implies a lower level of aggregate expenditure at each price level—a leftward shift of the Aggregate Demand curve.
55. A decrease in the price level would most likely shift the:
- Option : B
- Explanation : The LM curve represents the combinations of income and the interest rate at which the demand for real money balances equals the supply. For a given nominal money supply, a decrease in the price level implies an increase in the real money supply. To increase the demand for real money balances, either the interest must decrease or income must increase. Therefore, at each level of the interest rate, income (= expenditure) must increase — a rightward shift of the LM curve.
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