SECTION A
Answer ONLY ONE out of the two questions in this section
QUESTION 1
(a) Present a model of the labour market and use its equilibrium to derive an aggregate supply relation of the form y, = y * +8(p, where 0 < B <1, y, is the level of output, y * is the natural level of output, A is the price level — all measured in natural logs — while is the expectations operator. [12.5%]
(b) Explain the mechanisms that underlie the relation between price level and output in aggregate supply. Illustrate the relation diagrammatically and then show and explain the impact of a reduction in the expected price level. [10%]
(c) “Can a permanent/anticipated change in monetary policy affect output?” Provide an analysis that addresses this question, by combining the aggregate supply relation, with an aggregate demand relation of the form y, = m, — p,, where m, is the supply of money. [27.5%]
