WEEK 7 mq.docx

1. Supply shocks and the medium run.
Using the AS‐AD model with an interest rate rule, show the effects of an increase in unemployment benefits on the position of the AD and AS curves both in the short and in the medium run. Then state the effects on output, in the short run and in the medium run. Assume that before the changes, the economy was at the natural level of output. (Hint: you might need to analyses what happens to PS and WS relations in the medium‐run.)
AS: P=Pe1+μF1-YL,Z
AD: Y=YIn+aP-PT,G,T

Because of before the change, economy was at the nature level of output at price level Pe at point A.
In short run:
Increase in unemployment benefit lead increase in “z” which is catch-all variable in AS relation and the AS curve shifting right to AS’, and the equilibrium point moving from A to A’. At A’ the level of output Y’ is greater than the nature level of output YN, and the price level is lower than the expected price.
In the medium run:
Seen as the diagram below, because of the “z” increase in the labour market PS Shifting to PS’ and the equilibrium point change from A to B. At the same wage level .the unemployment rate is growing up from UN to Un’.
Because the P’ is lower than Pe, so the wage setter revise the expected price down and ,and central bank will increase the interest rate to decrease the output until the output level equal to the nature level of o