Question

Suppose the labor force increases in size due to a large level of immigration. At the same time real interest rates in a regular economy rise. What will happen in the economy?

	1) Equilibrium price in the economy will rise, equilibrium quantity is ambiguous.
	2) Equilibrium price in the economy will fall, equilibrium quantity is ambiguous.
	3) Equilibrium price in the economy is ambiguous, equilibrium quantity will rise.
	4) Equilibrium price in the economy is ambiguous, equilibrium quantity will fall.

Answer 1

1. Impact of increase in labour supply

Increase in labour supply would lead to fall in wage rate in the economy and thus decreasing cost of goods for the producers. Cost decrease will lead to increase in supply of goods in the economy. Thus affecting the supply side of economy.

2. Impact of rise in real interest rate

According to fisher's effect; real interest rates equal to the nominal interest rates minus inflation rate. So, increase in real interest rates could mean either increase in nominal interest rate or fall in inflation rate or they both are increasing but the rate at which nominal rates are incraesing is more than the increase in inflation rate.

Incraese in nominal rates mean the demand for money would decrease or in other words demand for goods would decrease. Thus, affecting the demand side economy.

Now, demand is decreasing and supply increasing this means prices are falling even if the rate of decrease in demand is less than rate of supply increase or vice-versa.

Equillibrium quantity change would be ambigous depending on the rate of change of demand and supply.

Hence, answer to aforementioned problem is

(2) Equilibrium price in the economy will fall, equilibrium quantity is ambiguous.