For simplicity, the IS model assumes that neither net exports nor net taxes vary with income. A more realistic (and complicated) model would drop such assumptions. How would the behavior of the IS curve differ in the more realistic model?
What will be an ideal response?
In a more realistic model, increases in income would result in both more imports being purchased and more taxes being paid. The purchase of imports instead of domestic output lessens the impact of expenditure changes on inventories and, thus, on equilibrium output. Shifts of the IS curve in response to changes in autonomous spending would be smaller. Taxes that rise with income reduce the size of changes in consumption spending in response to output changes, so again shifts of the IS curve are smaller. Changes in the real interest rate change expenditures, but the effect on output is reduced to the extent that imports and taxes are changing, so the more realistic IS curve is steeper than the curve in the text.
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If there is an increase in the price of the final good that an industry produces, the labor demand curve in the industry is likely to:
A) shift to the left. B) shift to the right. C) become vertical. D) become horizontal.
In the Keynesian model in the long run, an increase in taxes causes the price level to ________ and the real interest rate to ________
A) fall; rise B) fall; fall C) rise; rise D) rise; fall
If economists estimate the price elasticity of demand to be 0.75 for good X and 1.25 for good Y, then the government can raise the most revenue by taxing good Y
Indicate whether the statement is true or false
In a monopolistically competitive industry, firms set price
a. equal to marginal cost since each firm is a price taker. b. below marginal cost since each firm is a price taker. c. above marginal cost since each firm is a price setter. d. always a fraction of marginal cost since each firm is a price setter.