This question is considering an AD-AS model, with Price on the Y-axis and Real GDP on the X axis. The AS is composed of the Keynesian (horizontal), intermediate (upward sloping) and classical (vertical range.

I read that one explanation for the upward slope of the intermediate range is that as price level increases, output prices may increase beyond input price (due to rigidity). Hence, real value of inputs/costs falls, and it becomes more profitable to produce the good, and hence output increases.

Regarding this uneven increase in the nominal value of outputs and inputs, are they both reflected in the y-axis? Meaning, does the y-axis's aggregation of price contain both intermediate as well as final goods, or is it merely an estimation of final goods. I would think that in the former case, the rise in GPL on the graph (inducing increase in real GDP) contains both increases in output and input. In the latter case, the rise in GPL contains only output price increases, but the increase in input prices which lags behind is reflected off the graph.

I would think that in both cases, whether the increase in input prices is reflected on the y axis or not, the shape of the intermediate range still holds. Hence, is may not be significant. Is it simply a choice of what metric (CPI, etc.) I use to estimate price on my y axis?


I didn't quite well understood your question, but from what I could make of it I have answered the relation behind the formation of the Short run aggregate supply

In the short run, nominal rigidities , and/or imperfect information, make the AS curve positively sloped (SRAS - Short run aggregate supply)

enter image description here

The position of the SRAS curve is determined by the factors contributing to equilibrium in the labour market. In particular, an increase in the expected price level makes workers bargain for higher wages (for any given unemployment rate). The increase in the wage raises the actual price that firms set. As a result, an increase in the expected price level causes the AS curve to shift upwards

Diagrammatically , the SRAS curve should shift upwards ; enter image description here

enter image description here

This equation states that the deviation of the actual price level from the expected price level, P – Pe, is proportional to the deviation of output from its natural level, Y – Yn

If you are confused between Workers negotiation and AS fall or rise - you should read about the WS-PS model. The WS stands for wage setting, PS for price setting.

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  • $\begingroup$ Thank you for the clarification :). Very sorry for the convoluted phrasing. On a relook, I think my question can be summarised as: does the general price level include the prices of intermediate goods and factor inputs, or merely final goods and services. For example you mentioned workers negotiating higher wages. Does the fall in AS described reflect that higher wage directly (the divergence reflecting both increase in nominal wage and nominal prices of final goods), or indirectly (nominal prices of final goods). Or is it simply arbitrary, depending on what we use for our y axis (CPI, etc) $\endgroup$ – user7558 Mar 9 '16 at 2:07

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