A Theory of Supply Function Choice and Aggregate Supply
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. (JEL D21, D43, E13, E23, E31, E32)
Fields of Study & Subjects
Economic theories and models
Market Dynamics and Volatility
Monetary Policy and Economic Impact
Publication details
- Journal / source
- American Economic Review
- Publisher
- American Economic Association
- Volume
- 116
- Issue
- 2
- Pages
- 710–748
- Publication date
- 30 January 2026
- Language
- EN