11.

i. In this part of the question we are asked to assume that the shock is unanticipated
and individuals have adaptive expectations. The shock given is a negative supply
shock in the form of a decrease in world oil prices. Within the AS/AD space we see
that the short run aggregate supply curve is upward sloping due to the condition of
partially sticky prices. We see that the initial reaction to the price level produces a
shift of the SRAS from point A to point B. At this point price expectations for points A
and B are the same. Eventually as agents within the economy adapt the price
expectations at point B will be lower than those at point C. This is mainly due to a
decrease in the marginal productivity of labor or MPN. In the long run we see that
the SRAS moves to a vertical LRAS and shifts to the expected classical level of
output. (Y bar).
In the labor market we see a decrease in labor demand analogous to MPN1
and the initial price level. We eventually see a shift from this point at N’ to N1 which
is analogous to a MPN1 and price level 1. We then see a balancing shift in the labor
supply that decreases to point C. Which is analogous to price expectations 2. This
leaves us with a level of labor N2. This level of labor demand corresponds to MPN2,
which is equal to the initial level of MPN. These shifts in the labor supply curves are
a function of price expectations, which are adaptive meaning the agents within the
economy determine the expected price level by looking backwards at previous
periods. In the long run we have a level of labor that matches the original.

ii). In these part of the problem we have Unanticipated shock of an increase in oil
prices and rational expectations. This means we will see a shift of the supply curve
(SRAS) that will have a short term effect on the level of output, because the agents
within the economy do not have enough information to change their behavior and
counteract the shift. In the long run we see that LRAS settles at Y(bar) the classical
or long run level of output.
In the labor market we see that the labor demand shifts upward due to an
increase in the price level from Po to P1. Intuitively the demand for labor increases,
as the items that the laborers are producing are more valuable because we do not
see a simultaneous shift of the AD curve to counteract the increase in the price level.

iii). In this part of the problem we have a supply shock, the increase in oil prices,
being anticipated. We also have rational agents within the economy. As the supply
curve shifts to the left to denote the higher input prices, the AD curve
simultaneously shifts to the right to counteract the change in output to result in a
sole increase in the price level. This simultaneous shift is manifested in the fact that
the agents within the economy are rational and they have all possible information
available to them so we know they will make the correct adjustment given a shift in
the SRAS. In the long run we see that the level of output will be the same as it is
given the simultaneous shifts of both curves. However the price level will return to
its original level. This is caused mainly by the vertical supply curve in the long run.
In the labor market we see that there is a simultaneous shift of the labor
supply and demand curves so that we arrive at an equal level of labor N, yet a higher
nominal wage level W1. In the long run we also see a similar situation due to a
vertical labor supply curve causing the level of labor to remain the same but forcing
the wage level back to Wo.