Suppose an economy is characterized by the equations below.
Price setting: P = 11 + m21W> A2
Wage setting: W = Ae Pe11 - u2
a. Solve for the unemployment rate if Pe = P but Ae does not necessarily equal A. Explain the effects of 1Ae > A2 on the unemployment rate.
Now suppose that expectations of both prices and produc- tivity are accurate.
b. Solve for the natural rate of unemployment if the markup (m) is equal to 5%.
c. Does the natural rate of unemployment depend on pro- ductivity? Explain.