Are supply curves convex? Implications for state-dependent responses to shocks

This paper studies whether responses to shocks are state-dependent. To guide our empirical analysis we develop a putty-clay model in which short-run capacity constraints generate a convex supply curve at the industry level. Using a sufficient statistics approach, we estimate the model and find strong support for state- dependent responses to shocks. Industries with low initial capacity utilization rates expand production much more after dollar depreciations or defense spending shocks than industries that produce close to their capacity limit. Further, prices rise after such demand shocks only if the initial level of capacity utilization is high. Our evidence supports the view that supply curves are convex at the industry level and suggests that policies that raise demand are more effective during slumps.