The Wage Setting (WS), the Price Setting (PS) and the Aggregate Supply (AS) relations are given by: WS : Wt = P e t (? ? ?ut + z) PS : Pt = (1 + m)Wt AS : Pt = P e t (1 + m)(? ? ?ut + z)

(a) (10 points) Assume Pt = P e t for this question only. Suppose the unemployment benefits are decreased and the monopoly power is increased at the same time. Show graphically using the WS and PS curves how it affects the equilibrium in the Labor Market. Clearly label P S, W S, the equilibrium point and the natural rate of unemployment for both before and after implementing two polices. Circle the right changes for each variable below when you compare them with the case without two policies.

Question 1) The Labor Market & The Phillips Curve (30 points) The Wage Setting (WS), the Price Setting (PS) and the Aggregate Supply (AS) relations are given by: WS : Wt = PF(a - But + z) PS : P = (1 + m)Wt AS : P = PF(1 + m)(a - But + z) (a) (10 points) Assume Pr = Pf for this question only. Suppose the unemployment benefits are decreased and the monopoly power is increased at the same time. Show graphically using the WS and PS curves how it affects the equilibrium in the Labor Market. Clearly label PS, WS, the equilibrium point and the natural rate of unemployment for both before and after implementing two polices. Circle the right changes for each variable below when you compare them with the case without two policies. Wt > ut 1. Real wage: Increase / Decrease / Same / Ambiguous 2. The natural rate of unemployment: Increase / Decrease / Same / Ambiguous(b) (5 points) Suppose o = 1. Using the AS relation given above, show how we can transform the AS relation into the Non-linear Phillips Curve (PC). Moreover, transform it into the Linear PC at the end. (You do not need to show mathematical works to transform Non-linear PC into Linear PC) (c) (5 points) Derive the Modified Phillips Curve using the Linear PC you derived above. Explain any assumption you've made for of.(d) (10 points) Assume Pr = Pe. Using the Linear PC you derived above, calculate the natural rate of unemployment un and rewrite the Modified PC in terms of ut and un. (Hint: m and z must disappear when you rewrite the Modified PC!)