PROBLEM 1

Suppose that the firm's markup over costs is 6%, and the wage-setting equation is W = P(1 - u + z) , where u is the unemployment rate and z is equal to 0.03.

a. What is the real wage as determined by the price-setting equation?

b. What is the natural rate of unemployment?

PROBLEM 2

Using the WS and PS relations,graphically illustrate the effects of the following events on the natural rate of unemployment and on the real wage.

1. An reduction in unemployment insurance
2. Less stringent antitrust legislation
3. Increase in minimum wage

PROBLEM 3

Suppose the economy is initially operating at Yn. Now suppose the Fed conducts a monetary contraction where M^sdecreases.

1. Using AS and AD, and IS-LM graphs, illustrate the initial equilibrium, and medium run equilibrium.
2. What are the initial effects of the decrease inM^s Y, r, I, and C?
3. What happens to u and Y relative to their natural levels during: the short run, and the medium run?
4. What are the medium effects of the decrease in M^s on P, Y, r, I, and C?

PROBLEM 4

Assume π_t^e = π_t-1 and the Phillips curve for the United States is given by the following:

π_t- π_t-1 = -1.5(u_t -u_n).  Suppose ut = 0.06, u_n = 0.05 and π_t-1 = 0.04.

1. Calculate π_t. Is π_t greater than, less than or equal to π_t-1?
2. Calculate π_t for each of the following values of u_t = 0.07, and 0.08.
3. As u_t increase, is inflation in period t increasing or decreasing?

PROBLEM 5

Suppose there are two economies: A an B where u_t^A=6% and u_t^B= 5%

1. Given this information, what can you say, if anything, about the change in inflation in these two economies? Specifically, what happened to π_t (relative to π_t-1) in these two economies?
2. Suppose π_t^A< π_t-1^A. Given this information, where is u_t^A relative to the natural rate of unemployment?
3. Suppose π_t^B> π_t-1^B. Given this information, where is u_t^B relative to the natural rate of unemployment?