International financial market and korean economy Exercises for the ISLM Framework

Using the simple Keynesian modelconsider only the goods market equilibrium, 1 Demonstrate graphically and explain how a fall in investment reduces equilibrium output.. How do increases i

Exercises for the IS-LM Framework

Prepared by Seok-Kyun HUR

Question 1 Keynes believed that unstable investment caused

the Great Depression Using the simple Keynesian

model(consider only the goods market equilibrium),

(1) Demonstrate graphically and explain how a fall in investment reduces equilibrium output

(2) Assess the impact of $1 fall in investment on the

equilibrium output?

 Question 2 Equal increases in government spending and

taxes increase equilibrium output Explain and

demonstrate this graphically

 Size of the balanced budget fiscal multiplier is 1 in the goods

market.

 Will it hold the same magnitude if the money market is also

included in analysis?

 Question 3 The Federal Reserve increases interest rates

when they want to reduce aggregate demand to fight inflation How do increases in the interest rate reduce aggregate demand?

 Describe (a) channel(s) through which lowered

interest rate reduces the aggregate demand

 Question 4 Using the IS-LM model, show graphically

and explain the effects of a monetary expansion combined with a fiscal contraction How do the equilibrium level of output and interest rate change?

 Output?

 Interest rate?

 Question 5 Using the IS-LM model, show graphically

and explain the effects of a monetary contraction

(1) What is the effect on the equilibrium interest rate and level of output?

(2) Monetary contraction is made by CB’s Open Market Operation Then, what is its impact on the bond market?

 Question 6 Suppose that the demand for money is

completely insensitive to changes in the interest rate

(1) Explain and show graphically the effect of a fiscal expansion

(2) What is this effect called?

 Question 7 Suppose that the demand for money is

completely sensitive to changes in the interest rate

(1) Explain and show graphically the effect of monetary expansion

(2) What is this effect called?

 Question 8 Show graphically and explain why targeting

an interest rate is preferable when money demand is

unstable and the IS curve is stable

 Money demand is influenced by a certain random

factor, which cannot be controlled by anyone

 Interest rate targeting( inflation targeting is its official

name) is a monetary policy regime that the CB sustains a certain level of the policy rate