1. Macroeconomics of Business Cycles macro

2. Growth rates of real GDP, consumption Percent change from 4 quarters earlier Average growth rate Real GDP growth rate Consumption growth rate

3. Growth rates of real GDP, consumption, investment Percent change from 4 quarters earlier Investment growth rate Real GDP growth rate Consumption growth rate

4. Unemployment Percent of labor force

5. Okun’s Law Percentage change in real GDP Change in unemployment rate 1975 1982 1991 2001 1984 1951 1966 2003 1987 2008 1971

6. Facts about the business cycle  GDP growth averages about 3 percent per year over the long run with large fluctuations in the short run.  Consumption and investment fluctuate with GDP, but consumption tends to be less volatile and investment more volatile than GDP.  Unemployment rises during recessions and falls during expansions.  Okun’s Law: the negative relationship between GDP and unemployment.

7. Index of Leading Economic Indicators  Published monthly by the Conference Board.  Aims to forecast changes in economic activity 6-9 months into the future.  Used in planning by businesses and govt, despite not being a perfect predictor.

8. Components of the LEI index  Average workweek in manufacturing  Initial weekly claims for unemployment insurance  New orders for consumer goods and materials  New orders, nondefense capital goods  Vendor performance  New building permits issued  Index of stock prices  M2  Yield spread (10-year minus 3-month) on Treasuries  Index of consumer expectations

9. Index of Leading Economic Indicators Source: Conference Board 2004 = 100

10. Time horizons in macroeconomics  Long run Prices are flexible, respond to changes in supply or demand.  Short run Many prices are “sticky” at a predetermined level. The economy behaves much differently when prices are sticky.

11. Recap of classical macro theory  Output is determined by the supply side: – supplies of capital, labor – technology  Changes in demand for goods & services ( C, I, G ) only affect prices, not quantities.  Assumes complete price flexibility.  Applies to the long run.

12. When prices are sticky… …output and employment also depend on demand, which is affected by: – fiscal policy (G and T ) – monetary policy (M ) – other factors, like exogenous changes in C or I

13. AD/AS Model  The paradigm most mainstream economists and policymakers use to think about economic fluctuations and policies to stabilize the economy  Shows how the price level and aggregate output are determined  Shows how the economy’s behavior is different in the short run and long run

14. Aggregate demand  We use a simple theory of AD based on the quantity theory of money.  Recall the quantity equation M V = P Y  For given values of M and V, this equation implies an inverse relationship between P and Y : Y = (M V) / P

15. The downward-sloping AD curve An increase in the price level causes a fall in real money balances (M/P ), causing a decrease in the demand for goods & services. An increase in the price level causes a fall in real money balances (M/P ), causing a decrease in the demand for goods & services. Y P AD

16. Shifting the AD curve An increase in the money supply shifts the AD curve to the right. Y P AD 1 AD 2

17. Aggregate supply in the long run  Recall from Chapter 3: In the long run, output is determined by factor supplies and technology is the full-employment or natural level of output, at which the economy’s resources are fully employed. “Full employment” means that unemployment equals its natural rate (not zero).

18. The long-run aggregate supply curve Y P LRAS does not depend on P, so LRAS is vertical.

19. Long-run effects of an increase in M Y P AD 1 LRAS An increase in M shifts AD to the right. P1P1 P2P2 In the long run, this raises the price level… …but leaves output the same. AD 2

20. The short-run aggregate supply curve Y P SRAS The SRAS curve is horizontal: The price level is fixed at a predetermined level, and firms sell as much as buyers demand. The SRAS curve is horizontal: The price level is fixed at a predetermined level, and firms sell as much as buyers demand.

21. Short-run effects of an increase in M Y P AD 1 In the short run when prices are sticky,… …causes output to rise. SRAS Y2Y2 Y1Y1 AD 2 …an increase in aggregate demand…

22. From the short run to the long run Over time, prices gradually become “unstuck.” When they do, will they rise or fall? rise fall remain constant In the short-run equilibrium, if then over time, P will… The adjustment of prices is what moves the economy to its long-run equilibrium.

23. The SR & LR effects of  M > 0 Y P AD 1 LRAS SRAS P2P2 Y2Y2 A = initial equilibrium A B C B = new short- run eq’m after Fed increases M C = long-run equilibrium AD 2

24. SRAS LRAS AD 2 The effects of a negative demand shock Y P AD 1 P2P2 Y2Y2 AD shifts left, depressing output and employment in the short run. A B C Over time, prices fall and the economy moves down its demand curve toward full- employment.

25. Supply shocks  A supply shock alters production costs, affects the prices that firms charge (also called price shocks)  Examples of adverse supply shocks: – Bad weather reduces crop yields, pushing up food prices – Workers unionize, negotiate wage increases – New environmental regulations require firms to reduce emissions  Favorable supply shocks lower costs and prices

26. CASE STUDY: The 1970s oil shocks  Early 1970s: OPEC coordinates a reduction in the supply of oil  Oil prices rose 11% in 1973 68% in 1974 16% in 1975

27. SRAS 1 Y P AD LRAS Y2Y2 CASE STUDY: The 1970s oil shocks The oil price shock shifts SRAS up, causing output and employment to fall. A B In absence of further price shocks, prices will fall over time and economy moves back toward full employment. SRAS 2 A

28. CASE STUDY: The 1970s oil shocks Predicted effects of the oil shock: inflation  output  unemployment  …and then a gradual recovery.

29. CASE STUDY: The 1970s oil shocks Late 1970s: As economy was recovering, oil prices shot up again, causing another huge supply shock!!!

30. CASE STUDY: The 1980s oil shocks 1980s: A favorable supply shock-- a significant fall in oil prices. As the model predicts, inflation and unemployment fell:

31. Stabilization policy  def: policy actions aimed at reducing the severity of short-run economic fluctuations.  Example: Using monetary policy to combat the effects of adverse supply shocks…

32. Stabilizing output with monetary policy SRAS 1 Y P AD 1 B A Y2Y2 LRAS The adverse supply shock moves the economy to point B. SRAS 2

33. Stabilizing output with monetary policy Y P AD 1 B A C Y2Y2 LRAS But the Fed accommodates the shock by raising agg. demand. results: P is permanently higher, but Y remains at its full- employment level. SRAS 2 AD 2

34. Aggregate Demand I: The IS-LM Model The IS-LM model determines income and the interest rate in the short run when P is fixed

35. The Big Picture Keynesian Cross Theory of Liquidity Preference IS curve LM curve IS-LM model Agg. demand curve Agg. supply curve Model of Agg. Demand and Agg. Supply Explanation of short-run fluctuations

36. The Keynesian Cross  A simple closed economy model in which income is determined by expenditure.  Notation: I = planned investment PE = C + I + G = planned expenditure Y = real GDP = actual expenditure  Difference between actual & planned expenditure = unplanned inventory investment

37. Elements of the Keynesian Cross consumption function: for now, planned investment is exogenous: planned expenditure: equilibrium condition: govt policy variables: actual expenditure = planned expenditure

38. The equilibrium value of income income, output, Y PE planned expenditure PE =Y PE =C +I +G Equilibrium income

39. An increase in government purchases Y PE PE =Y PE =C +I +G 1 PE 1 = Y 1 PE =C +I +G 2 PE 2 = Y 2 YY At Y 1, there is now an unplanned drop in inventory… …so firms increase output, and income rises toward a new equilibrium. GG

40. Solving for  Y equilibrium condition in changes because I exogenous because  C = MPC  Y Collect terms with  Y on the left side of the equals sign: Solve for  Y :

41. The government purchases multiplier Example: If MPC = 0.8, then Definition: the increase in income resulting from a $1 increase in G. In this model, the govt purchases multiplier equals An increase in G causes income to increase 5 times as much!

42. Why the multiplier is greater than 1  Initially, the increase in G causes an equal increase in Y:  Y =  G.  But  Y   C  further  Y  further  C  further  Y  So the final impact on income is much bigger than the initial  G.

43. An increase in taxes Y PE PE =Y PE =C 2 +I +G PE 2 = Y 2 PE =C 1 +I +G PE 1 = Y 1 YY At Y 1, there is now an unplanned inventory buildup… …so firms reduce output, and income falls toward a new equilibrium  C =  MPC  T Initially, the tax increase reduces consumption, and therefore PE:

44. Solving for  Y eq’m condition in changes I and G exogenous Solving for  Y : Final result:

45. The tax multiplier def: the change in income resulting from a $1 increase in T : If MPC = 0.8, then the tax multiplier equals

46. The tax multiplier …is negative: A tax increase reduces C, which reduces income. …is greater than one (in absolute value): A change in taxes has a multiplier effect on income. …is smaller than the govt spending multiplier: Consumers save the fraction (1 – MPC) of a tax cut, so the initial boost in spending from a tax cut is smaller than from an equal increase in G.

47. The IS curve def: a graph of all combinations of r and Y that result in goods market equilibrium i.e. actual output = planned expenditure The equation for the IS curve is: J.R. Hicks

48. Y2Y2 Y1Y1 Y2Y2 Y1Y1 Deriving the IS curve  r   I Y PE r Y PE =C +I (r 1 )+G PE =C +I (r 2 )+G r1r1 r2r2 PE =Y IS II   PE  Y Y

49. Why the IS curve is negatively sloped  A fall in the interest rate motivates firms to increase investment spending, which drives up total planned spending (PE ).  To restore equilibrium in the goods market, output (a.k.a. actual expenditure, Y ) must increase.

50. Fiscal Policy and the IS curve  We can use the IS-LM model to see how fiscal policy (G and T ) affects aggregate demand and output.  Let’s start by using the Keynesian cross to see how fiscal policy shifts the IS curve…

51. Y2Y2 Y1Y1 Y2Y2 Y1Y1 Shifting the IS curve:  G At any value of r,  G   PE   Y Y PE r Y PE =C +I (r 1 )+G 1 PE =C +I (r 1 )+G 2 r1r1 PE =Y IS 1 The horizontal distance of the IS shift equals IS 2 …so the IS curve shifts to the right. YY

52. NOW YOU TRY: Shifting the IS curve:  T  Use the diagram of the Keynesian cross or loanable funds model to show how an increase in taxes shifts the IS curve.

53. The Theory of Liquidity Preference  Due to John Maynard Keynes  A simple theory in which the interest rate is determined by money supply and money demand

54. Money supply The supply of real money balances is fixed: M/P real money balances r interest rate

55. Money demand Demand for real money balances: M/P real money balances r interest rate L (r )L (r )

56. Equilibrium The interest rate adjusts to equate the supply and demand for money: M/P real money balances r interest rate L (r )L (r ) r1r1

57. How the Fed raises the interest rate To increase r, Fed reduces M M/P real money balances r interest rate L (r )L (r ) r1r1 r2r2

58. The LM curve Now let’s put Y back into the money demand function: The LM curve is a graph of all combinations of r and Y that equate the supply and demand for real money balances. The equation for the LM curve is:

59. Deriving the LM curve M/P r L (r, Y1 )L (r, Y1 ) r1r1 r2r2 r Y Y1Y1 r1r1 L (r, Y2 )L (r, Y2 ) r2r2 Y2Y2 LM (a) The market for real money balances (b) The LM curve

60. Why the LM curve is upward sloping  An increase in income raises money demand.  Since the supply of real balances is fixed, there is now excess demand in the money market at the initial interest rate.  The interest rate must rise to restore equilibrium in the money market.

61. How  M shifts the LM curve M/P r L (r, Y1 )L (r, Y1 ) r1r1 r2r2 r Y Y1Y1 r1r1 r2r2 LM 1 (a) The market for real money balances (b) The LM curve LM 2

62. The short-run equilibrium The short-run equilibrium is the combination of r and Y that simultaneously satisfies the equilibrium conditions in the goods & money markets: Y r IS LM Equilibrium interest rate Equilibrium level of income

63. Policy analysis with the IS -LM model We can use the IS-LM model to analyze the effects of fiscal policy: G and/or T monetary policy: M IS Y r LM r1r1 Y1Y1

64. causing output & income to rise. IS 1 An increase in government purchases 1. IS curve shifts right Y r LM r1r1 Y1Y1 IS 2 Y2Y2 r2r2 1. 2. This raises money demand, causing the interest rate to rise… 2. 3. …which reduces investment, so the final increase in Y 3.

65. IS 1 1. A tax cut Y r LM r1r1 Y1Y1 IS 2 Y2Y2 r2r2 Consumers save (1  MPC) of the tax cut, so the initial boost in spending is smaller for  T than for an equal  G… and the IS curve shifts by 1. 2. …so the effects on r and Y are smaller for  T than for an equal  G. 2.

66. 2.…causing the interest rate to fall IS Monetary policy: An increase in M 1.  M > 0 shifts the LM curve down (or to the right) Y r LM 1 r1r1 Y1Y1 Y2Y2 r2r2 LM 2 3.…which increases investment, causing output & income to rise.

67. The Fed’s response to  G > 0  Suppose Congress increases G.  Possible Fed responses: 1. hold M constant 2. hold r constant 3. hold Y constant  In each case, the effects of the  G are different…

68. If Congress raises G, the IS curve shifts right. IS 1 Response 1: Hold M constant Y r LM 1 r1r1 Y1Y1 IS 2 Y2Y2 r2r2 If Fed holds M constant, then LM curve doesn’t shift. Results:

69. If Congress raises G, the IS curve shifts right. IS 1 Response 2: Hold r constant Y r LM 1 r1r1 Y1Y1 IS 2 Y2Y2 r2r2 To keep r constant, Fed increases M to shift LM curve right. LM 2 Y3Y3 Results:

70. IS 1 Response 3: Hold Y constant Y r LM 1 r1r1 IS 2 Y2Y2 r2r2 To keep Y constant, Fed reduces M to shift LM curve left. LM 2 Results: Y1Y1 r3r3 If Congress raises G, the IS curve shifts right.

71. Estimates of fiscal policy multipliers from the DRI macroeconometric model Assumption about monetary policy Estimated value of  Y /  G Fed holds nominal interest rate constant Fed holds money supply constant 1.93 0.60 Estimated value of  Y /  T  1.19  0.26 Barro & Redlick (2010) 0.90  1.10 Romer & Bernstein (2009) 1.55  0.90

73. Shocks in the IS -LM model IS shocks: exogenous changes in the demand for goods & services. Examples: – stock market boom or crash  change in households’ wealth   C – change in business or consumer confidence or expectations   I and/or  C

74. Shocks in the IS -LM model LM shocks: exogenous changes in the demand for money. Examples: – a wave of credit card fraud increases demand for money. – more ATMs or the Internet reduce money demand.

75. CASE STUDY: The U.S. recession of 2001  During 2001, – 2.1 million jobs lost, unemployment rose from 3.9% to 5.8%. – GDP growth slowed to 0.8% (compared to 3.9% average annual growth during 1994-2000).

76. CASE STUDY: The U.S. recession of 2001 Causes: 1) Stock market decline   C 300 600 900 1200 1500 199519961997199819992000200120022003 Index (1942 = 100) S&P 500

77. CASE STUDY: The U.S. recession of 2001 Causes: 2) 9/11 – increased uncertainty – fall in consumer & business confidence – result: lower spending, IS curve shifted left Causes: 3) Corporate accounting scandals – Enron, WorldCom, etc. – reduced stock prices, discouraged investment

78. CASE STUDY: The U.S. recession of 2001  Fiscal policy response: shifted IS curve right – tax cuts in 2001 and 2003 – spending increases airline industry bailout NYC reconstruction Afghanistan war

79. CASE STUDY: The U.S. recession of 2001  Monetary policy response: shifted LM curve right Three-month T-Bill Rate 0 1 2 3 4 5 6 7 01/01/200004/02/2000 07/0 3/2000 10/03/2000 01/03/200104/05/200107/06/200110/06/200101/06/200204/08/200207/09/2002 10/09/2002 01/09/2003 04/11/2003

80. Y1Y1 Y2Y2 Deriving the AD curve Y r Y P IS LM(P 1 ) LM(P 2 ) AD P1P1 P2P2 Y2Y2 Y1Y1 r2r2 r1r1 Intuition for slope of AD curve:  P   (M/P )  LM shifts left  r r  I I  Y Y

81. Monetary policy and the AD curve Y P IS LM(M 2 /P 1 ) LM(M 1 /P 1 ) AD 1 P1P1 Y1Y1 Y1Y1 Y2Y2 Y2Y2 r1r1 r2r2 The Fed can increase aggregate demand:  M  LM shifts right AD 2 Y r  r r  I I   Y at each value of P

82. Y2Y2 Y2Y2 r2r2 Y1Y1 Y1Y1 r1r1 Fiscal policy and the AD curve Y r Y P IS 1 LM AD 1 P1P1 Expansionary fiscal policy (  G and/or  T ) increases agg. demand:  T   C  IS shifts right   Y at each value of P AD 2 IS 2

83. IS-LM and AD-AS in the short run & long run Recall from Chapter 9: The force that moves the economy from the short run to the long run is the gradual adjustment of prices. rise fall remain constant In the short-run equilibrium, if then over time, the price level will

84. The SR and LR effects of an IS shock A negative IS shock shifts IS and AD left, causing Y to fall. Y r Y P LRAS IS 1 SRAS 1 P1P1 LM(P 1 ) IS 2 AD 2 AD 1

85. The SR and LR effects of an IS shock Y r Y P LRAS IS 1 SRAS 1 P1P1 LM(P 1 ) IS 2 AD 2 AD 1 In the new short-run equilibrium,

86. The SR and LR effects of an IS shock Y r Y P LRAS IS 1 SRAS 1 P1P1 LM(P 1 ) IS 2 AD 2 AD 1 In the new short-run equilibrium, Over time, P gradually falls, causing SRAS to move down M/P to increase, which causes LM to move down Over time, P gradually falls, causing SRAS to move down M/P to increase, which causes LM to move down

87. AD 2 The SR and LR effects of an IS shock Y r Y P LRAS IS 1 SRAS 1 P1P1 LM(P 1 ) IS 2 AD 1 SRAS 2 P2P2 LM(P 2 ) Over time, P gradually falls, causing SRAS to move down M/P to increase, which causes LM to move down Over time, P gradually falls, causing SRAS to move down M/P to increase, which causes LM to move down

88. AD 2 SRAS 2 P2P2 LM(P 2 ) The SR and LR effects of an IS shock Y r Y P LRAS IS 1 SRAS 1 P1P1 LM(P 1 ) IS 2 AD 1 This process continues until economy reaches a long-run equilibrium with

89. NOW YOU TRY: Analyze SR & LR effects of  M a. Draw the IS-LM and AD-AS diagrams as shown here. b. Suppose Fed increases M. Show the short-run effects on your graphs. c. Show what happens in the transition from the short run to the long run. d. How do the new long-run equilibrium values of the endogenous variables compare to their initial values? Y r Y P LRAS IS SRAS 1 P1P1 LM( M 1 /P 1 ) AD 1

90. The Great Depression Unemployment (right scale) Real GNP (left scale) 120 140 160 180 200 220 240 192919311933193519371939 billions of 1958 dollars 0 5 10 15 20 25 30 percent of labor force

91. THE SPENDING HYPOTHESIS: Shocks to the IS curve  asserts that the Depression was largely due to an exogenous fall in the demand for goods & services – a leftward shift of the IS curve.  evidence: output and interest rates both fell, which is what a leftward IS shift would cause.

92. THE SPENDING HYPOTHESIS: Reasons for the IS shift  Stock market crash  exogenous  C – Oct-Dec 1929: S&P 500 fell 17% – Oct 1929-Dec 1933: S&P 500 fell 71%  Drop in investment – “correction” after overbuilding in the 1920s – widespread bank failures made it harder to obtain financing for investment  Contractionary fiscal policy – Politicians raised tax rates and cut spending to combat increasing deficits.

93. THE MONEY HYPOTHESIS: A shock to the LM curve  asserts that the Depression was largely due to huge fall in the money supply.  evidence: M1 fell 25% during 1929-33.  But, two problems with this hypothesis: – P fell even more, so M/P actually rose slightly during 1929-31. – nominal interest rates fell, which is the opposite of what a leftward LM shift would cause.

94. THE MONEY HYPOTHESIS AGAIN: The effects of falling prices  asserts that the severity of the Depression was due to a huge deflation: P fell 25% during 1929-33.  This deflation was probably caused by the fall in M, so perhaps money played an important role after all.  In what ways does a deflation affect the economy?

95. THE MONEY HYPOTHESIS AGAIN: The effects of falling prices  The stabilizing effects of deflation:   P   (M/P )  LM shifts right   Y  Pigou effect: P  (M/P )P  (M/P )  consumers’ wealth   C C  IS shifts right  Y Y

96. THE MONEY HYPOTHESIS AGAIN: The effects of falling prices  The destabilizing effects of expected deflation:  E   r  for each value of i  I  because I = I (r )  planned expenditure & agg. demand   income & output 

97. THE MONEY HYPOTHESIS AGAIN: The effects of falling prices  The destabilizing effects of unexpected deflation: debt-deflation theory  P (if unexpected)  transfers purchasing power from borrowers to lenders  borrowers spend less, lenders spend more  if borrowers’ propensity to spend is larger than lenders’, then aggregate spending falls, the IS curve shifts left, and Y falls

98. Why another Depression is unlikely  Policymakers (or their advisors) now know much more about macroeconomics  Federal deposit insurance makes widespread bank failures very unlikely.  Automatic stabilizers make fiscal policy expansionary during an economic downturn.

99. The Great Recession 2008-2009  NBER: December 2007 to June 2009 – Real GDP fell by 4%, u-rate hit 10.6%  Important factors in the crisis:

100. Interest rates and house prices

101. Change in U.S. house price index and rate of new foreclosures, 1999-2009

102. House price change and new foreclosures, 2006:Q3 – 2009Q1 New foreclosures, % of all mortgages Cumulative change in house price index Nevada Georgia Colorado Texas Alaska Wyoming Arizona California Florida S. Dakota Illinois Michigan Rhode Island N. Dakota Oregon Ohio New Jersey Hawaii

103. U.S. bank failures by year, 2000-2010

104. Major U.S. stock indexes (% change from 52 weeks earlier)

105. Consumer sentiment and growth in consumer durables and investment spending

106. Real GDP growth and Unemployment

107.  NBER: December 2007 to June 2009 – Real GDP fell by 4%, u-rate hit 10.6%  Important factors in the crisis: – early 2000s Federal Reserve interest rate policy – sub-prime mortgage crisis – bursting of house price bubble, rising foreclosure rates – falling stock prices – failing financial institutions – declining consumer confidence, drop in spending on consumer durables and investment goods The Great Recession 2008-2009

108. Policy Responses to Great Recession  Fiscal Policy – Economic Stimulus Act of 2008 – TARP (2008) – American Recovery and Reinvestment Act of 2009 – Cash for Clunkers (2009) – Additional UI  Monetary Policy – Quantitative Easing I, II – New Credit Facilities  Financial Regulation – Stress tests – Dodd-Frank (2010)  International Trade Policy

109. Clicker Review

110. Over the business cycle, investment spending ______ consumption spending. a) is inversely correlated with b) is more volatile than c) has about the same volatility as d) is less volatile than

111. Most economists believe that prices are: a) flexible in the short run but many are sticky in the long run. b) flexible in the long run but many are sticky in the short run. c) sticky in both the short and long runs. d) flexible in both the short and long runs.

112. The vertical long-run aggregate supply curve satisfies the classical dichotomy because the natural rate of output does NOT depend on: a) the labor supply. b) the supply of capital. c) the money supply. d) technology.

113. If the short-run aggregate supply curve is horizontal, then a change in the money supply will change ______ in the short run and change ______ in the long run. a) only output; only prices b) only prices; only output c) both prices and output; only prices d) both prices and output; both prices and output

114. Assume that the economy is initially at point A with aggregate demand given by AD 2. A shift in the aggregate demand curve to AD 0 could be the result of either a(n) ______ in the money supply or a(n) ______ in velocity. a) increase; increase b) increase; decrease c) decrease; increase d) decrease; decrease

115. In the IS-LM model, which two variables are influenced by the interest rate? a) supply of nominal money balances and demand for real balances b) demand for real balances and government purchases c) supply of nominal money balances and investment spending d) demand for real money balances and investment spending

116. The equilibrium condition in the Keynesian- cross analysis in a closed economy is: a) income equals consumption plus investment plus government spending. b) planned expenditure equals consumption plus planned investment plus government spending. c) actual expenditure equals planned expenditure. d) actual saving equals actual investment.

117. In the Keynesian-cross model with a given MPC, the government-expenditure multiplier ______ the tax multiplier. a) is larger than b) equals c) is smaller than d) is the inverse of the

118. An increase in taxes shifts the IS curve, drawn with income along the horizontal axis and the interest rate along the vertical axis: a) downward and to the left. b) upward and to the right. c) upward and to the left. d) downward and to the right.

119. A decrease in the price level, holding nominal money supply constant, will shift the LM curve: a) upward and to the right. b) downward and to the right. c) downward and to the left. d) upward and to the left.

120. In the Keynesian-cross analysis, if the consumption function is given by C = 100 + 0.6(Y – T), and planned investment is 100, G is 100, and T is 100, then equilibrium Y is: a) 350 b) 400 c) 600 d) 750

121. Based on the graph, starting from equilibrium at interest rate r 1 and income Y 1, a tax cut would generate the new equilibrium combination of interest rate and income: a) r 2, Y 2 b) r 3, Y 2 c) r 2, Y 3 d) r 3, Y 3

122. Based on the graph, starting from equilibrium at interest rate r 3, income Y 2, IS 1, and LM 1, if there is an increase in government spending that shifts the IS curve to IS 2, then in order to keep the interest rate constant the Federal Reserve should _____ the money supply shifting to _____. a) increase; LM 2 b) decrease; LM 2 c) increase; LM 3 d) decrease; LM 3

123. Based on the graph, if the economy starts from a short- term equilibrium at A, then the long-run equilibrium will be at ____ with a _____ price level. a) B; higher b) B; lower c) C; higher d) C; lower

124. A tax cut combined with tight money, as was the case in the United States in the early 1980s, should lead to a: a) rise in the real interest rate and a fall in investment. b) fall in the real interest rate and a rise in investment. c) rise in both the real interest rate and investment. d) fall in both the real interest rate and investment.