Consider an economy with fixed exchanged rates. Suppose the price-setting equation is given by P= (1+m) The wage-setting equation is given by W = Pen(u, where m is the markup. z are unemployment benefits. u is the unemployment rate. and A is productivity. Assume that A and AC are constant.

1. Suppose a foreign economy engages in a fiscal contraction. Use the Three-Figures Diagram: money market, the IS-04 curves. and the interest parity condition curve to show the effects of this policy on domestic output, interest rate and exchange rate in the following two cases:

a. Assume that the change in foreign interest rate is larger than the change in domestic interest rate caused by the initial shift of domestic IS curve. [6 marks]

b. Assume that the change in foreign interest rate is equal to the change in domestic interest rate caused by the initial shift of domestic IS curve. [6 marks]

c. Compare your results and explain? [4 marks]

2. Assume that the economy is at the medium run equilibrium. but it experiences an increase in productivity. A. What happens to its natural rate of unemployment if people's expectations about prices and productivity are correct? Why? Draw the wage-setting and price-setting lines on a diagram with u on x-axis and W/Pon y-axis. Show the change of the natural rate of unemployment in the diagram? [8 marks]

3. Determine the equilibrium condition in the labour market? [3 marks]

4. Derive the AS equation for this economy? [2 marks]

5. Assume people's expectations about productivity are correct, and this year's expected inflation rate equals last year's inflation rate. Also, assume that

F(ut, z) = 1 + z - ut Derive the Phillips curve for this economy? Plot this curve on a graph with unemployment rate on x-axis and the change in the inflation rate on y-axis? [6 marks]

Consider an economy with fixed exchanged rates. Suppose the price-setting equation is given by _ E P _ (1 l m] A The wage-setting equation is given by W = PEAEPTH, z} where m is the markup, zare unemployment benefits. uis the unemployment rate, and A is productivity. Assume that A and A2 are constant. 1. Suppose a foreign economy engages in a fiscal contraction. Use the Th ree'Figures Diagram; money market. the iS-LM curves. and the interest parity condition curve to show the effects of this policy on domestic output. interest rate and exchange rate in the following two cases: a. Assume that the change in foreign interest rate is larger than the change in domestic interest rate caused by the initial shift of domestic i3 curve. [6 marks] 1}. Assume that the change in foreign interest rate is equal to the change in domestic interest rate caused by the initial shift of domestic 5 curve. [15 marks] 1:. Compare your resuits and explain? {4 marks] 2. Assume that the economy is at the medium run equilibrium, but it experiences an increase in productivity, A. What happens to its natural rate of unemployment if people's expectations about prices and productivity are correct? Why? Draw the wage-setting and price-setting lines on a diagram 1with uon raxis and WfPon yr axis. Show the change of the natural rate of unemployment in the diagram? [8 marks] 3. Determine the equilibrium condition in the labour market? [3 marks] 4. Deriye the AS equation for this economy? 12 marks] 5. Assume people's expectations about productivity are correct. and this year's expected inflation rate equals last year's inflation rate. Also. assume that Fimlzl=1+zts Deriye the Phillips curve for this economy? Plot this curve on a graph with unemployment rate on Xvaxis and the change in the inflation rate on y-axis? [5 marks]