Econ 312 Macroeconomic Theory Question 1. The labor market In an economy, the firms profit-maximize by comparing the MPL to the wage: 0.5 A • √K/√L = w And workers negotiate their wage raises by looking at the # of jobs and the expected inflation: EP P The productivity is A=3.7 and there is K = 36 of capital. (a) Prior to shocks and policies, the economy is in equilibrium with EP=P=2. Find the equilibriu number of workers. Then find the equilibrium wage. W = •VI (b) Now the actual price level P₁ falls below the expected price level EP. Graph the labor market. Clearly label axes and curves. Show the distance that represents the disequilibrium. Label the before and after equilibria with E, and E₁. Answers are provided 1. (a) 11.1, (b) 3.33 (c) Name one shock that could result in this change on the labor market. Be specific about its type and direction.

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