A Theory of Supply Function Choice and Aggregate Supply

69 Pages Posted: 26 Jun 2023 Last revised: 3 Apr 2024

See all articles by Joel P. Flynn

Joel P. Flynn

Yale University

Georgios Nikolakoudis

Princeton University

Karthik Sastry

Princeton University - Department of Economics

Date Written: April 1, 2024

Abstract

Modern theories of aggregate supply are built on the foundation that firms set prices and commit to producing whatever the market demands. We remove this strategic restriction and allow firms to choose supply functions, mappings that describe the prices charged at each quantity of production. Theoretically, we characterize firms’ optimal supply function choices in general equilibrium and study the resulting implications for aggregate supply. Aggregate supply flattens under lower inflation uncertainty, higher idiosyncratic demand uncertainty, and less elastic demand. Quantitatively, our theory explains the flattening of aggregate supply during the Great Moderation and steepening during the 1970s and 2020s.

Keywords: Supply Functions, Business Cycles, Uncertainty, Aggregate Supply, Phillips Curve

JEL Classification: E31, E32, E50

Suggested Citation

Flynn, Joel P. and Nikolakoudis, Georgios and Sastry, Karthik, A Theory of Supply Function Choice and Aggregate Supply (April 1, 2024). Available at SSRN: https://ssrn.com/abstract=4490683 or http://dx.doi.org/10.2139/ssrn.4490683

Joel P. Flynn (Contact Author)

Yale University ( email )

493 College St
New Haven, CT CT 06520
United States

Georgios Nikolakoudis

Princeton University ( email )

Julis Romo Rabinowitz Building
Princeton, NJ 08544
United States
6093563619 (Phone)

Karthik Sastry

Princeton University - Department of Economics ( email )

Princeton, NJ 08544-1021
United States

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