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Interest Rate Shocks and Unemployment in Europe

Interest Rate Shocks and Unemployment in Europe. (a) Consider that the economy is populated by households with preferences given by (CT)1 where Cr denotes consumption of traded goods and CN consumption of nontraded goods. Derive the demand function for non-tradables as a function of the real exchange rate p. (b) Nontraded goods are produced by perfectly competitive firms using labor, lit, as the only factor input. The production function for nontraded goods is given by:
QN = 0.7
Derive the supply of nontraded goods as a function of the real exchange rate p and hourly wage rate expressed in unit of tradables (c) Assume that the exchange rate is fixed E = E, and nominal wage is downwardly rigid We > Wt_1. Plot the supply and the demand functions in the space (h,p) and analyze i. the effect of an increase in the world interest rate on wage and unemployment ii. the effect of a decline in the world interest rate on wage and unemployment

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