1. (4 pts)

Mark the following statements as T or F and provide a one-sentence explanation. If the statement is false, you can provide a correction.

? Investment is a function of final sales and the interest rate.

? The IS curve shifts down because taxes reduce income.

? The LM curve is horizontal at the interest rate the central bank chooses.

? The LM curve is a set of all pair of interest rates and incomes at which the financial markets are in equilibrium.

? As the price level rise, the real money supply falls.

? An increase in government purchases lowers the IS curve.

? If fiscal policy is expansionary, monetary policy must be as well.

? The 2001 recession was caused by the 9/11 attack.

2. (2pts)

The book argues that investment is a negative function of interest rates because businesses borrow to invest (buy new capital goods). But many businesses use retained earnings (their own saved funds) to make such purchases. Why should their investment depend on the interest rate? Does it? Explain briefly.

3. (4 pts)

Draw the IS-LM graph in both panels and label both axes and curves.

In the left panel, show what will happen if consumer confidence rises.

In the right panel, show what happens if the Fed raises the interest rate.