Question

2. Consider an economy where production is given by Y = AN. Assume that price setting and wage setting are given by: Price setting: P=(1+m) Wage setting: W=AⓇP® (1 – u) Recall that the relation between employment (N), the labour force (L) and the unemployment rate (u) is given by: N= (1-u)L (a) Derive the aggregate supply curve (that is, the relation between the price level and the level of output given by the markup, the actual and expected level of productivity, the labour force and the expected price level).

Answer 1

Answer 2)

Productivity and aggregate supply curve, The production function of an economy is given as follows: Y = AN .....(1) Where, Total output that economy can produce is represented by Y (full-employment), The state of technology and the labor productivity is represented by A. The price and wage settings are as follows: P=(1+4) And, W = AⓇP® (1-4) Where, Price is represented by P, Mark-up is represented by u, and Nominal wage is represented by W. The employment equation is as follows:

N =(1-4) ....(4) Where, Labor force is represented by L, and Employment status is represented by N.

(a) From equation (1) the total output requires as follows: Y = AN Now firms set the price by adjusting the cost of production and mark-up, so derivation is as follows: P=(1+4) P= (1+x)( AP(1-4) (::W = AⓇP® (1–4) -0.** =(1+4) (:(1-4)= (*) (1+) AⓇP®

(1+x)=P(1)-(+)) (1+x)(4P (2) (1+y)(AP® (Y)) Ax AL (1+4) APY AL Hence, price is directly related to expected productivity, expected price, output and mark-up price.

It seems the relationship is rightly established: - Actual price is directly related to expected price, implying that as the expectation about the price changes, actual price also changes in the same direction, considering the economic agent are rational. - Price is directly related to expected productivity but inversely related to actual productivity. This is because as the expectation of works about the productivity increase, they try to revise their wage upward, and hence price increase - On the other hand, increase in actual productivity increase the amount of quantity supply, which causes the price to fall.

Output is directly related, implying that as the output increase the capacity installed are more intensely utilized, and due to increasing cost of production price increases - As the labor force increases, it put downward pressure on wage rate, hence leads to decrease in price.