1. Consider an economy at its long-run equilibrium. A new government is elected and decides to cut unemployment insurance.

What would be the effect on workers reservation wage? Describe the potential effects of this policy on labor supply and describe the short-term changes on the labor market equilibrium. Use charts, words and, if you think it is needed, equations.

Describe the short-run effects of this policy on output and prices.

What are the short-term effects on the overall economy? In particular, on the real wage, the interest rate, consumption, investment, employment and the real money supply. Show all steps using all relevant diagrams and formulas for each individual market and for the economy overall. Give economic intuition for each answer.

Now consider the long-run effects of such policy: consider all the variables mentioned above and include the natural rate of unemployment. As above, show all steps using all relevant diagrams and formulas for each individual market and for the economy overall. Give economic intuition for each answer. No full credit if you do not follow every step.