Consider an economy that is described by the following. (1) Labor Market In the labor market, there is a representative firm whose capital stock is fixed and has a production function 1 = A 5N -Nwhere A is the level of current productivity, which includes both Y technology and prices of input bundles such as energy. Y is the real output. The MPN of the representative firm is the following. MPN = A(5 N) re are homogenous workers whose labor supply curve is The N = 2.5 + (1- T)w is the level of labor income tax, and w is the real wage rate. The where t level of TFP A=2, and the current labor income tax rate t = 25%. (2) Goods Market The desired consumption and the desired investment are given by the following. cd = 2 - 4r + 0.6(Y T) 1d = 2.6 + MPKf - 2r Tk The current level of Government spending G=5, and the level of taxes T=5. The future marginal product of capital MPK' is 2. The current revenue tax T = 0%. (3) Money Market The real money demand function is Md 0.02Y P r+rThe nominal money supply is 24, and the price level is fixed in the short-run at P=12. The expected inflation rate is given by 10%. (4) Okun's Law It is known that Okun's Law is satisfied in this economy. Y - Y 10( - ) Y where the natural rate of unemployed u is 5%. 1. (10pts) The full-employment level N is the equilibrium level of employment in the labor market. Calculate the full-employment level N, and the full-employment level of output Y. 2. (10pts) Derive the IS and LM curves. 3. (10pts) Calculate the equilibrium real interest rate r, real output Y, and current level of unemployment u. Graphically illustrates three curves: IS, LM, and FE in (Y,r)-plane. 4. (10pts) Is this economy at the general equilibrium? If not, explain how the economy will be adjusted toward the general equilibrium, and graphically illustrates the adjustment process. 5. (20pts) How do the following shocks affect the real interest rate, output and prices? Briefly explain each case using IS-LM-FE graph. For simplicity, assume that the economy is at the general equilibrium before each shock. a. A negative supply shock (A decrease in A) b. A positive shock on the future marginal product of capital (An increase in MPK) c. A positive shock on the expected inflation d. An increase in Government spending 6. (10pts) Instead of the flexible wage, suppose the real wage is determined by the efficiency wage model. The efficiency wage in this economy is 2.5. Calculate the excess supply of labor. What is the full-employment level of output under the efficiency wage?