The AS curve

Say that nominal wage in year 1 (at a particular point in time) is equal to 1000. On the horizontal part of response curve, real wage is constant and equal to its maximum value. Let's say that (W/P) MAX = 10. On horizontal part P1 = 100 where P1 is the price level in year 1. Firms will use at most LB at this real wage. For firms to hire more than LB, P1should be higher than 10. We realize that AS curve at this point in time, AS1 will look like before. First, it's horizontal along P = 10, then for higher Y. it is upward sloping.

Assume that Π_W is equal to 10%. Subsequent year, nominal wages would be equal to 1100. Wages in year 2 are determined by ?Wthat is an exogenous variable, making wages in year 2 exogenous. As maximum real wage is given and equal to 10, we determine that P2 is equal 110 on the horizontal part of response curve and that P₂> 110 on the downward sloping part. AS2 glides upwards up by 10% as given by wages inflation. Using same argument, P₃ = 121 on horizontal part of the response curve at year 3 and so on.

Just like AD curve, AS curve is to glide downwards or upwards depending on whether Π_W < 0 or Π_W > 0 when we allow for inflation. As for AD curve, AS curve is applicable only at a specific point in time if Π_W ≠ 0. At another point in time, we should draw a new AS curve.

Figure: AS curve gliding if Π_W ≠ 0

Posted Date: 8/19/2013 3:53:09 AM | Location : United States

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