# The consumption function shifts down if ....... fall(s). a. taxes b. autonomous consumption c....

## Question:

The consumption function shifts down if ....... fall(s).

a. taxes

b. autonomous consumption

c. government spending

d. none of the above

A monetary policymaker is better off targeting the money supply when the ..... curve is unstable.

a.money demand

b. IS

c. LM

d. aggregate demand

The IS curve slopes down because as the interest rate rises:

a. borrowing costs rise.

b. the net present value of business projects falls.

c. the domestic currency strengthens, dampening export demand.

d. all of the above.

If interest rates rise, which of the following would fall?

a. taxes

b. autonomous consumption

c. investment

d. all of the above

The LM curve will shift to the left if output is ..... its natural rate.

a. above

b. below

c. equal to

d. cannot be determined

## ISLM model

IS curve known as investment spending curve shows the inverse relationship between interest rate and income in the goods market. LM stands for liquidity preference curve represents a positive relationship between income and interest rate. LM curve represents equilibrium in money market where demand for money is equal to supply of money.

## Answer and Explanation:

**Option b is correct**

The consumption function represents a functional relationship between total consumption and total income.

{eq}\begin{align*} {\rm{C}} = \overline {\rm{C}} + {\rm{cY}}\\ {\rm{ }} \end{align*} {/eq}

Here {eq}{\rm{ }}\overline {\rm{C}} {/eq} represents autonomous consumption

Where c represents the marginal propensity to consume which depends on disposable income Y

This relationship shows that the consumption function shifts down with the fall in autonomous consumption.

**Explanation of incorrect options.**

**Option a is incorrect.**

Consumption function does not shift down with fall in taxes. Disposable income is the income left after paying for taxes and receiving transfers. The taxes are generally induced which leads to change in the slope of consumption function.

**Option c is incorrect.**

Government spending increases the aggregate demand and therefore the income. Government spending on transfers increases the disposable income which will affect the slope of consumption function.

**A monetary policymaker is better off targeting the money supply when the curve is unstable.**

A monetary policy maker is better off targeting the money supply when the IS curve is unstable.

The ISLM model has a major implication in regard with the monetary policy. A money supply target leads to greater output generation when the IS curve is unstable. The central bank targets the money supply whenever the IS curve is unstable.

**Explanation of incorrect options.**

**Option c is incorrect.**

When the LM curve in unstable, an interest rate target leads to greater macroeconomic stability.

**option a is incorrect.**

A monetary policy maker prefers the money supply target only in case when IS curve is unstable. The LM curve represents equilibrium at appoint where demand for money is balanced with supply of money so the demand for money does not affect the monetary policy maker decision.

**Option d is incorrect.**

According to our question, the monetary policymaker targets money supply only in case where IS curve is unstable not in the case of AD curve being unstable.

**The IS curve slopes down because as the interest rate rises**

**all of the above**

The IS curve slopes down because as the interest rate rises, the investment will fall which will decrease the aggregate demand and increase the income.

**Option a is correct.**

The interest rate increase will increase the borrowing cost. It will be costly to borrow due to higher interest rate.

**Option b is correct.**

The interest rate increase will decrease the net present value of business projects. There will be fewer investments on business projects because of high interest rate.

**Option c is correct.**

The rise in interest rate above the world interest rate will attract the foreign investors and therefore lead to capital inflow which will strengthen the domestic currency.

**Option d is correct**

The appreciation of domestic currency will lead to increase in imports and decrease in exports.

**If interest rates rise, which of the following would fall**

The increase in interest rate will lead to fall in investment. Their exists an inverse relationship between interest rate and investment. Higher interest rate discourages the investors to invest.

**Option a is incorrect.**

The rise in interest rate does not influence taxes. Fiscal policy of the government determines the tax rate.

**Option b is incorrect.**

The interest rate rise will not affect the autonomous consumption spending. Autonomous consumption spending is independent of change in income and interest rate.

**The LM curve will shift to the left if output is .... its natural rate**

The LM curve will shift to the left when output is above its natural rate. The natural rate of output is the level of output in the long run at which the prices are stable. When the output is above the natural rate the price level will rise. An increase in price will not affect the IS curve. The rise in price leads to decrease in decrease in real money balances,keeping the nominal money supply constant due to which LM curve will shift left.

**Option b is incorrect**

When output is below the natural rate, the price level will fall which will therefore increase the real money supply and will shift the LM curve to the right.

**Option c is incorrect**

The output is equal to its natural rate means that there will be no shift in the LM curve as prices are stable.

#### Learn more about this topic:

from Introduction to Business: Homework Help Resource

Chapter 3 / Lesson 46