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2. Effect of a Change in Labor Market Regulations Recently the government has introduced a new set of complicated labor market regulations. As a results of this, the natural rate of unemployment ugoes up and the natural level of output Ya drops. Your friend, who knows nothing about the economy, asks you about the impact of such a change on the economy. You try to make use of your knowledge of the IS-LM model and AD- AS model to impress your friend. Before the change in Yn, the economy is in a medium-run equilibrium and output is at some initial level of Yn For parts a) to d), please draw an a riate graph to illustrate your answer clearly*** a) How does the decrease in Yn affect output Y and interest rate i, if we assume that price level P and expected price level Pe are both constant? Explain your answer b) Suppose you believe that investment is very elastic to interest rate i, how will you modify your answer for a)? Explain your answer c) Suppose your friend is also interested in how output Y and interest ratei are affected in the further future when price level P can adjust but expected price level Pe is still constant. How will you modify your answer for )? Explain your answer d) Suppose your friend is also interested in how output Y and interest rate i are affected in the even further future, when both price level P and expected price level Pe can adjust. How will you modify your answer for a)? Explain your answer carefully e) Your friend then asks you how private investment I is affected by the change in Yn Please answer your friend under different assumptions i) price level P and expected price level Pe are constant, ) price level P can adjust but expected price level P is constant and i) both price level P and expected price level Pe are flexible. Explain your answer. (No graph is needed)

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