Consider an economy with SRAS curve:

Y = Ybar + a(P - EP)

Where Ybar is the natural rate of output and EP is the expected price level.

a)Depict a long run equilibrium of the closed economy AD-AS on a graph with Y on the horizontal axis and P on the vertical axis.Show the short run effects of a negative aggregate demand shock.Give one example of such a shock.Label your graph well.You don't need to solve for numbers in parts a) and b) of this question.

b) Carefully show how the economy will return to a new long run equilibrium in the absence of fiscal or monetary policy after the shock in part a).

c) Okun's Law states that:

u - ubar = -b(Y - Ybar)

Where ubar is the natural rate of unemployment.Derive the Phillips Curve.Is there a permanent trade-off between inflation and unemployment that policy makers can exploit?Discuss the role of expectations.

d) Consider two aggregate supply curves.The first has a slope of a = 2 and the second has a slope of a'=1.Which supply curve do you think is associated with "stickier" prices?