Question

In an IS-LM model, any point that is to the left and below the IS-curve indicates a situation where

A. there is excess demand for goods and services in the expenditure sector

B. there is excess supply of goods and services in the expenditure sector

C. there is excess demand for money in the money sector

D. there is excess supply of money in the money sector

E. the expenditure sector is in equilibrium but the money sector is not

Answer 1

Solution:

Investment-spending (IS) curve marks all the points where the goods and services market (or expenditure sector) is in equilibrium. Similarly, LM curve marks all points where the money market is in equilibrium (such that demand for money,L, equals the supply of money, M).

Then, if a point is to the left and below IS curve, it means a point is away from IS curve, so goods and services market cannot be in equilibrium (eliminating option (E)). Furthermore, we can claim that point is away from IS curve, but we can't say for sure that point is away from LM curve, thus, money market may be or may not be in equilibrium (eliminating (C) and (D)).

Finally, to the left and below IS curve, for a particular value of output, interest rate, r, is lower meaning people do not get good enough interest rate return on saving thus they prefer to spend more at current (lower) rate, so aggregate demand exceed aggregate supply in goods and services market. Thus, at the specified point, there must be excess demand for goods and service.

Thus, correct option is (A).