In Blanchard's Macroeconomics textbook, Aggregate Supply relation is derived from wage setting and price setting equations as such: $P = (1+m) W = (1+m)P^e F(u,z)$, which implies that an increase in output (or equivalently a reduction in unemployment rate) leads to higher wage (W) as the bargaining power of the workers increase, and this leads to higher prices through price setting equation. As a result, we have upward sloping AS curve showing positive relation between prices and output. In other textbooks, they explain upward sloping AS curve with sticky wage or sticky price theories. I would like to understand if the first method (WS-PS equations) have any link to sticky wage or sticky price theories. What is confusing is that in the above WS-PS setting, both Wage and Price increase when unemployment rate is low, and this still explains upward sloping AS relation. Maybe, assumptions underlying these 2 different methods are the reasons for different formulations. Then, which method would be more useful to explain why AS curve is upward sloping?



Your Answer

By clicking “Post Your Answer”, you agree to our terms of service and acknowledge you have read our privacy policy.