3. (i) Explain the economic intuition behind the upward sloping wage-setting curve in the real wage and employment space? [3]

(ii) Assume that the economy initially at the WS-PS equilibrium. What happens when there is a sudden upswing in the aggregate demand in the economy? [7]

(iii) Use the WS-PS model to graphically derive a set of Phillips curves and explain the economic intuition behind the diagram. Provide an explanation of how a situation of deflation could occur. What are you assuming about the real interest rate in the deflationary scenario? [15]