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## The AS relation

At A-level you might have seen the AS curve presented in the form of a ‘short run’ AS curve which is horizontal, and a ‘long run’ AS curve which is vertical. In Blanchard’s textbook he presents it in a much more logical way – an upward sloping AS curve, which moves up and down according to expected price level. This is basically how you get from a horizontal short-run, to a vertical long-run, except Blanchard defines ‘long-run’ as ‘medium-run’, because long-run really means long term growth models like the Solow growth model that are not concerned with economic fluctuations but with the growth of the long run supply potential of the economy.

The upward sloping AS curve basically shows how output influences prices. As output rises, this drives up prices, which is one explanation for why you generally get inflation in a growing economy.

Start by combining the price-setting and wage-setting relations:
$P=(1+\mu )W$ and $W=P^e F(u,z)$ means $P=(1+\mu )P^e F(u,z)$. This is the AS relation.

Now given that the AS model has P on the vertical axis and Y on the horizontal axis, if we are going to draw a curve from that relation, we need Y to be in there somewhere. Well it sort of is, because u is in there, we could express u as a function of Y.

The logic here is that there will be an inverse relation between u and Y. When there is greater demand for goods and Y increases, more workers are hired and so u falls. When Y is falling, there is less need for workers so workers are made redundant, and u rises. So really u in the AS relation kind of represents output, but in an inverse way, as rising Y means falling u.

So how does the AS curve link output to prices?

1 As output increases, more workers are hired to produce the extra output, so unemployment falls.
2 As unemployment falls, workers get more bargaining power, so the WS relation shifts up, wages rise.
3 As wages rise, the PS relation implies that higher W means higher P, so higher wages make prices rise.
4 As workers see prices are rising then expected prices rise. The WS relation implies that higher expected prices mean higher wages, so wages rise.