Suppose the closed economy is in long-run equilibrium. Immigration of skilled workers shifts the long-run aggregate supply curve $60 billion to the right. At the same time, government purchases increase by $40 billion. If the MPC equals 0.75 and the crowding-out effect is $160 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

The increase in skilled workers due to immigration will shift the long-run aggregate supply curve to the right, resulting in an increase in real GDP in the long run. The government purchases will increase aggregate demand, leading to an increase in the price level. However, the crowding-out effect of $160 billion will cause a reduction in private investment, which means the increase in government purchases is partially offset. 
The increase in aggregate supply due to the shift in the long-run aggregate supply curve will be greater than the increase in aggregate demand due to the government purchases, leading to an increase in real GDP and a decrease in the price level. Therefore, the correct answer is C.

Suppose the Closed Economy Is in Long-Run Equilibrium