Suppose the economy is characterised by the following equations:

Price setting: P = (1+m) (W/A)

Wage setting: W = A^{e} P^{e} (1-u)

where A is the unobserved and difficult to estimate technology parameter in the production function Y=AN, and A^{e} 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 A^{e} =11.

d. Explain the effects of A e /A on the unemployment rate. For example, explain what happens if actual A rises significantly but A^{e}doesn't in the medium run -- would this mean technology improves or worsens the natural rate of unemployment?

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