a. Explain why, in the wage-setting relation, there is a negative relationship between real wages and the unemployment rate. (3 marks)

b. Discuss the concept of the equilibrium (or natural) rate of unemployment in a model with imperfect markets. Show how an increase in the mark-up over costs affects the equilibrium (or natural) rate of unemployment and real wages. (3 marks)

c. Assume that the economy starts at the natural rate of output. Now suppose there is a decrease in consumer confidence with increasing interest rates. As a result, households attempt to increase their saving for a given level of disposable income. Use the AD/AS diagram to show the effects in the short run and the medium run. Show how expansionary fiscal policy may influence these equilibrium positions. (4 marks)