Assume the IS-MP model and the AS-AD model are in the long-run equilibrium,

hence

Y t = Y t

r t = r

t =

As the level of output and the inflation rate lie on the AS curve in equi-

librium, the labour market is in equilibrium with an equilibrium real wage,

w t =

W t

P t

, and an equilibrium unemployment rate, u t , consistent with the equi-

librium rate of inflation and the output level.

The central bank's monetary rule follows a Taylor rule and the IS curve is iden-

tical to the one discussed in class.

Consider the impact of a temporary and unanticipated decrease in labour pro-

ductivity.

1. Discuss the changes in the labour market. How does the equilibrium

real wage and the unemployment rate change? Use graphs to substantiate

your answer. (5 points)

2. Analyse and explain the impact of the shock in the short-run. Use graphs

to substantiate your answer. (10 points)

3. Analyse and explain the impact of the shock in the medium-run. Use

graphs to substantiate your answer. (10 points)