Suppose the closed economy is in long-run equilibrium. Technological change shifts the long-run aggregate supply curve $80 billion to the right. At the same time, government purchases increase by $40 billion. If the MPC equals 0.8 and the crowding-out effect is $70 billion, what would we expect to happen in the long-run to real GDP and the price level?
A)Both real GDP and the price level would be higher.
B)Both real GDP and the price level would be lower.
C)Real GDP would be higher but the price level would be lower.
D)Real GDP would be higher but the price level would be the same.

Question

Quizplus · Accepted Answer

Technological change shifts the long-run aggregate supply curve to the right, increasing real GDP. Government purchases increase, but the crowding-out effect reduces the increase in real GDP. The MPC of 0.8 means that the increase in government purchases will lead to a further increase in real GDP. The overall effect is that real GDP increases. The increase in real GDP will lead to an increase in the price level.

Suppose the Closed Economy Is in Long-Run Equilibrium