Suppose the economy is characterised by the following equations:
Price setting: P = (1+m) (W/A)
Wage setting: W = Ae Pe (1-u)
where A is the unobserved and difficult to estimate technology parameter in the production function Y=AN, and Ae is its expected value.
First suppose that expectations of both prices and technology are accurate.
a. Solve for the natural rate of unemployment and medium-run real wage rate if the markup, m, is equal to 10 per cent and A = 11.
b. Does the natural rate of unemployment depend on technology? Explain.
c. Solve for the natural rate of unemployment and medium-run real wage rate if A=5.5, and Ae =11.
d. Explain the effects of A e /A on the unemployment rate. For example, explain what happens if actual A rises significantly but Aedoesn't in the medium run -- would this mean technology improves or worsens the natural rate of unemployment?
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