Labor Market Theory Assume that the labor market in a fictional country is characterized by a downward-sloping labor demand (Ld(w) : %) and an upward-sloping labor supply (L5 (w) : 2-w2). a. Unemployment rate We can show, although you are not required to do so for this exercise, that equilibrium wage for this economy is u:* = 5, and equilibrium employment is I,* = 50. Given what is shown in Figure 1, if the government of Harponia were to impose a minimum wage of 5.5. what would be the unemployment rate (M) predicted by the frictionless model? Figure 1: Frictionless Labor Model L'(W) Wm=5.5 w*= L\"! w) Ld(5.5)=4|.32 L*=50 Ls(5.5)=6o.5 L b. Taming Wage increases In recent months the Federal Reserve has argued that part of the inflation that we are seeing in the U.S. can be traced back to increases in wages in the labor market. For this reason it has tried to implement policies to reduce labor demand and tame wage increases, although analysts fear that this may lead to increases in unemployment. Use the graphical analysis of the frictionless model, under the situation where the minimum wage is below the equilibrium wage, to explain why a decrease in labor demand can lead to a decrease in wages. Explain also why only if the decrease in labor demand is very large this will lead to an increase in unemployment. [Note: Foil credit for this question requires the correct graph]