Introduction

Some time ago Stigler (1939) and Hart (1951) made the observation that demand fluctuations are best met by flexible plants, characterised by flat bottomed average cost curves. Actually, if a variety of plant designs are feasible, it may typically be efficient to build plants of different types and to allocate output among them so as to minimise expected total production costs. It is natural to inquire whether a competitive equilibrium will sustain such an efficient solution.

This question has been recently considered by Sheshinski and Drèze (S–D) (1976). In their model, an industry which consists of plants of different designs produces an output, the demand for which is randomly distributed. At each realisation of demand, the price of output is determined competitively so as to equate the output supplied by the firms present in the industry with the given level of demand. Entry and exit of firms is assumed to be governed by expected profits; that is, firms are risk neutral. The equilibrium number of firms is such that no firm in the industry has positive expected profits, and all potential entrants’ expected profits, calculated at the equilibrium price distribution, are non-positive. S–D have analysed the characteristics of the equilibrium distributions of outputs and prices. They have also shown that any competitive equilibrium satisfies the necessary conditions for efficient production – defined as minimisation of the expected cost of meeting the random demand.