Asymmetries in price and quantity adjustments by the competitive firm
Focusing on the crucial role of inventory carry-overs in the production and sales decision, we describe the profit maximizing behavior of a dynamic competitive firm facing random prices. Each firm’s behavior is incorporated into a stochastic equilibrium model of the competitive industry with uncertain demand. The industry model exhibits asymmetric cyclical fluctuations of the “Keynesian” sort: when demand is weak, output contracts while price holds at a fixed floor; when demand is strong, price increases as output is constrained by a ceiling. Even in a pure world of constant returns, without increasing costs, the inability to instantaneously coordinate production and sales along with the existence of inventories is sufficient to yield a “backward I,” shaped supply curve for the short run. Journal of Economic Literature Classification Numbers: 020, 021. 022.