JUse that the Phillips curve is given by

T₁ = π₁ + (m+z) – aut,

πt

where is the inflation rate, is the expected inflation rate, m is the markup of prices over

wages, z is a catch-all variable, and ut

of wage flexibility - the higher is a, the greater is the response of the wage to a change in the

the unemployment rate. We can think of a as a measure

unemployment rate, aut.

1. Suppose m = = 0.03 and z = 0.003. What is the natural rate of unemployment if a = 1? If

a = 2? What is the relation between a and the natural rate of unemployment? Explain

in words.