Question 2 O pts Question 2: AS-AD Model (10 marks) Suppose that one economy is initially at the natural level of output and assume that the production function of the economy is Y=AN, where Y is the output, N is the labor and A is the state of technology and A=1. Now suppose that there is an exogenous shock such that A decreases from 1 to 0.5 permanently. a) (1 mark) Assume that the nominal wage is W. What is the marginal cost of production (i.e., the cost of producing one more unit of output) when A=1? What is the marginal cost of production when A=0.5? b) (3 marks) Write down the price setting relation and the wage setting relation when A=1 and when A=0.5, respectively. Draw a diagram for the labor market to show the effect of such an increase in A on the natural rate of unemployment? Briefly explain. c) (6 marks) What happens to (1) output, (2) the price level, and (3) the interest rate in the short run and in the medium run? Illustrate your results in an AS-AD diagram and an IS-LM diagram. Briefly state the reason(s) why you shift the curve(s) in the diagrams. Show the correspondence between two diagrams. Label the original curves as AS, AD, IS, and LM. Label the short-run curves as ASSR, ADsr, ISSR, and LMsR. Label the medium-run curves as ASMR, ADMR, ISMR, and LMMR. Indicate the initial equilibrium point, short-run equilibrium point, and the medium-run equilibrium point. Question 2 O pts Question 2: AS-AD Model (10 marks) Suppose that one economy is initially at the natural level of output and assume that the production function of the economy is Y=AN, where Y is the output, N is the labor and A is the state of technology and A=1. Now suppose that there is an exogenous shock such that A decreases from 1 to 0.5 permanently. a) (1 mark) Assume that the nominal wage is W. What is the marginal cost of production (i.e., the cost of producing one more unit of output) when A=1? What is the marginal cost of production when A=0.5? b) (3 marks) Write down the price setting relation and the wage setting relation when A=1 and when A=0.5, respectively. Draw a diagram for the labor market to show the effect of such an increase in A on the natural rate of unemployment? Briefly explain. c) (6 marks) What happens to (1) output, (2) the price level, and (3) the interest rate in the short run and in the medium run? Illustrate your results in an AS-AD diagram and an IS-LM diagram. Briefly state the reason(s) why you shift the curve(s) in the diagrams. Show the correspondence between two diagrams. Label the original curves as AS, AD, IS, and LM. Label the short-run curves as ASSR, ADsr, ISSR, and LMsR. Label the medium-run curves as ASMR, ADMR, ISMR, and LMMR. Indicate the initial equilibrium point, short-run equilibrium point, and the medium-run equilibrium point
