A major war breaks out in Europe, which leads to a large increase in the price of

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Question:

A major war breaks out in Europe, which leads to a large increase in the price of oil and gas.

a) After carefully explaining the intuition for the wage-setting/price-setting model (WS-PS), show how this increase in the relative price of energy affects equilibrium real wages, unemployment, and output. (15 marks)

b) If the war ends quickly and relative energy prices return to their pre-war levels, use the WSPS diagram to compare real wages, unemployment, and output in the pre-war and post-war medium-run equilibria. (5 marks)

c) If the war continues for a long time, and relative energy prices remain very high, explain what will happen to the real wage, unemployment, and output (5 marks)