American Economic Review
ISSN 0002-8282 (Print) | ISSN 1944-7981 (Online)
A Theory of Supply Function Choice and Aggregate Supply
American Economic Review
(pp. 710–48)
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 can rationalize the flattening of aggregate supply during the Great Moderation and steepening during the 1970s and 2020s.Citation
Flynn, Joel P., George Nikolakoudis, and Karthik A. Sastry. 2026. "A Theory of Supply Function Choice and Aggregate Supply." American Economic Review 116 (2): 710–48. DOI: 10.1257/aer.20240443Additional Materials
JEL Classification
- D21 Firm Behavior: Theory
- D43 Market Structure, Pricing, and Design: Oligopoly and Other Forms of Market Imperfection
- E13 General Aggregative Models: Neoclassical
- E23 Macroeconomics: Production
- E31 Price Level; Inflation; Deflation
- E32 Business Fluctuations; Cycles