1. Consider the model of the labor market with mark-up pricing and bargaining-determined wages. Assume the real wage is set according to the equation for WS in linear form:

W/P^e = A^e (1 - au + z)

And the price-setting equation (PS) is:

P = (1+m) W/A

All variables are as defined in Chapter 13 in Blanchard. For this question, you should assume A=A^e.

a.) Explain using intuition why A^e and u are included in the WS equation.

b.) Draw these equations for WS and PS on the W/P and u graph. Solve for the equilibrium value of u_n (the natural rate of unemployment). What assumption are you using as you solve for equilibrium?

c.) Suppose stronger intellectual property rights and increased monopoly power raise the value of m, the markup factor. Show the changes on your graph and describe the new medium-run equilibrium.

d.) Now suppose that as a result of the offshoring of more jobs, workers have reduced bargaining power and the vector z falls. Begin with a new graph of WS and PS and predict medium-run effects on W/P and u_n. Explain your results using the logic of the model. Do you think the prediction about the real wage is ^erealistic? Explain your view.

The role of technical change

2. Assume WS and PS are as described in #1, except that A may differ from A^e.

a.) Draw the graph of WS and PS and also solve (mathematically) for the medium-run equilibrium. What assumptions are you using?

b.) Suppose that A rises by more than A^e. Analyze the impact on the medium-run equilibrium. Explain the change in natural unemployment using intuition.

c.) Now suppose the rise in A exactly equals the rise in A^e. Analyze the new medium-run equilibrium, both graphically and mathematically. Explain how and why it differs from your answer in part b.