Consider the Labor Market Graph above. This graph shows the labor market conditions in a hypothetical country. The natural rate of unemployment in this country is 5 percent. In other words, even during normal times 5 percent of the labor force is unemployed. The natural unemployment is solely due to labor market frictions. The potential GDP in this country equals Yp = 100,000. Okun's alpha equals 2. Currently the labor market is in equilibrium and there is no cyclical unemployment in the country. Suppose that business firms become optimistic about future economic conditions and start investing in plants and equipment and hiring more workers. The increase in demand for goods and services results in 50 percent increase in the general price level. The resulting excess demand for labor causes the money wage to increase by 20 percent. So now we have the following: Nominal (or money) wage = Price level - Real wage =

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