2. (i) (a) Consider the wage setting and price setting relationships. Using appropriate graphs, (ii) (iii) explain how the WS-PS relationships determine the natural rate of unemployment. Be sure to explain any specic assumption that needs to be made. (b) Using suitable graphs explain how each of the following can separately affect the natural rate of unemployment: (A) the amount of unemployment compensation paid to unemployed workers is reduced; (B) price of oil in world market increases sharply; (C) the Justice Department takes a very tough stance on businesses and attempts to reduce monopoly power. (c) In an economy the wage setting relationship is given by W = Pe(1-1.5u), where u is the unemployment rate, Pe the expected price level and W the nominal wage rate. The aggregate production function is given by Y = N, where Y is output and N the level of employment. Furthermore, rms follow a mark-up pricing formula to set the price. The mark-up (applied over the marginal cost of production) is 10 % (or 0.1). Calculate the natural rate of unemployment. How will your answer change if the mark up falls to 8% (or 0.08). (20) We have the following information for an economy. Y" =1600, e = - = 3%, Initially, r}, = 2%. Investment depends only on the real borrowing rate, r+x, where r is the real interest rate and x the risk premium. Consider the followin situations, A throu_ C. I-------- 1750 mmn-I- IllM.\" 1450 - Explain the characteristics of a medium run equilibrium. For each situation described above, explain if it is a medium run equilibrium. If it is not a medium run equilibrium, explain what has happened that has caused the economy to deviate from the medium run equilibrium. Explain the appropriate monetary policy that the central bank needs to undertake to move the country to a medium run equilibrium. Explain the central bank's action in terms of adjustment of the nominal interest rate. For each situation illustrate your answers with suitable graphs of IS, LM and PC curves. Draw the IS-LM curves with real interest rate in the vertical axis. Hint: The central bank's action rst affects the level of investment by a'ecting the borrowing rate. But as investment increases (or decreases) so does the GDP and consequently, the level of consummion. (20) Suppose the economy is at a medium run equilibrium. Using the graphs of the IS-LMPC model, explain the impact of a sharp decrease in oil price. Explain how the central bank should adjust the real rate of interest to stabilize the rate of ination. Assume, it? = rtt_1