Consider an economy in which all workers are covered by contracts that specify the nominal wage and give the employer the right to choose the amount of employment. The production function is
Y = 20ˆšN
and the corresponding marginal product of labour is
Y= 10/ˆšN.
Suppose that the nominal wage W = 20.
a. Derive an equation that relates the real wage to the amount of labour demanded by firms (the labour demand curve*).
b. For the nominal wage of 20, what is the relation between the price level and the amount of labour demanded by firms?
c. What is the relation between the price level and the amount of output supplied by firms? Graph this relation.
Now suppose that the IS and LM curves of the economy (the goods market and asset market equilibrium conditions) are described by the following equations:

d. The money supply M is 300. Use the IS and LM equations to derive a relation between output F and the price level P. This relation is the equation for the aggregate demand curve. Graph this relation on the same axis as the relation between the price level and the amount of output supplied by firms (the aggregate supply curve) from part (c).
e. What are the equilibrium values of the price level, output, employment, the real wage, and the real interest rate?
f. Now suppose that the money supply M is 135. What are the equilibrium values of the price level, output, employment, the real wage, and the real interest rate?

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IS curve LM curve Y = 120-500r. M/P = 0.5Y-500r.