Question

Suppose your economy resides at long‐run potential output but concerns arise that the birth rate is too low to support retired workers on fixed social security payments. Suppose further that technology growth is insignificant. If population is allowed to rise through immigration, what happens to the long‐run aggregate supply curve, prices and interest rates? What could happen to the LR supply curve, prices and interest rates if immigration remained restricted?

Answer 1

An increase in the number of workers in the form of immigration will result in increasing the potential of the economy to produce an increased level of output. Because now the labour force is bigger the economy can produce more even if its productivity remains same. This will shift the long run aggregate supply curve to the right and so the full employment level of GDP will increase.

Because immigration is allowed we expect that the consumption expenditure and investment expenditure will also increase because this increased population will spend the earned income. Therefore aggregate demand will shift outwards. The price level will increase in the nation and because there will be inflation, we expect that firms will find it difficult to produce at increased cost of production so they reduce production and borrow less. If there is nothing done by the government or the central bank the interest rate will fall.

If the immigration is not allowed in the current labour force continue to squeeze, then the full employment level will fall in future because there are reduced number of workers when more of them are retiring. The long run aggregate supply curve will shift to the left. This time however there will be no reduction in the consumption demand because the retirees will continue to consume. This shift however will increase the price level because the initial short run aggregate supply curve and aggregate demand curves are unchanged.