Pricing and Production Without the Invisible Hand

Joel P. Flynn, George Nikolakoudis and Karthik A. Sastry
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Joel P. Flynn: Yale University
George Nikolakoudis: Yale University
Karthik A. Sastry: Princeton University

No 2501, Cowles Foundation Discussion Papers from Cowles Foundation for Research in Economics, Yale University

Abstract: Modern theories of the business cycle do not allow for the simultaneous rational choice of both prices and quantities, instead assuming that an Òinvisible handÓ determines one of these variables to clear markets. In this paper, we develop a macroeconomic framework in which both prices and quantities are chosen directly by firms, and exchange is both voluntary and efficient. Because of uncertainty about demand and productivity, individual product markets can be in excess supply or rationed. The absence of market-clearing changes pricing and production in qualitatively important ways: markups are no longer determined solely by the elasticity of demand, and higher uncertainty reduces production and increases markups.

Pages: 80 pages
Date: 2026-02-01
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