Economics of Sellers Competition Machlup

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of Sellers'Conduct

by FRITZ MACHLUPH utzlet' Professor of Political Economy The Johns H opkins University

1 95 2Baltimore: The Johns Hopkins Press

Books by


Die Goldkernwlihrung (1925) Die neuen Wiihrungen in Europa (1927) Borsenkredit, Industriekredit und Kapitalbildung (1931) Fuhrer durch die Krisenpolitik (1934) Guide travers les panacees economiques (1938) The Stock Market, Credit and Capital Formation (1940) International Trade and the National Income Multiplier (1943) The Basing-Point System (1949) The Political Economy of Atlonopoly (1952) The Economics of Sellers' Competition (1952)


Copyright 1952, The Johns Hopkins Press. Distributed in Great Britain by Geoffrey Cumberlege, Oxford University Press, London. Printed in the U.S.A~ by VaU-Ballou Press. SECOND PRINTING, 1956 TI:IIRD PRINTING, 1960 FOURTH PRINTING; 1964

Author's PrefaceALTHOUGH a clear and readable style of writing has been one .fl.of my major objectives, I doubt that this book will make suitable reading for the raw beginner in the study of economics, unless he is. very smart I shall be very happy if I have succeeded in writing a .book suitable for both the intermediate and advanced student.and also for the expert in the field. I realize that an expert gets easily bored if he has to trudge over wide stretches of familiar ground. But to publish only for the expert-jumping over everything that he may be expected to know well-is nowadays a luxury that professional journals can afford, but not the publishers of books. The writer of a book must address a somewhat wider audience and must go over much of the ground that less advanced students have to cover if they are to comprehend the entire discussion. But often a fresh approach to a subject, starting from first principles, may hold new insights even for the most jaded specialist. If I have succeeded in my endeavours, this book should be useful in many courses in intermediate and advanced economics. Its sub-title, Model Analysis of Sellers' Conduct, is not meant to advertise it asa model of analysis, but to indicate that it emphasizes the method of analysing economic problems by constructing and manipulating well-designed models of relevant human conduct. This emphasis, . I hope,. will beuseful far beyond the subject matter of this book and may .make its study worth while even in courses in which "competition and monopoly" is only a smallpor:tion of the agenda. Although I recognize the power of mathematical arguments and the usefulness of geometric aids in economic analysis, I have made little use of them. The 26. graphs and the one page of algebra that are included in this book are not part of the text and thus can be skipped with the greatest of ease. While this may please the majority of readers, I shall perhaps be chided for it by my critics. But it has been my aim to keep the book as far as possible within the confines of literary economics.




The plan of the book is probably clear from the table of contents: an introductory Part I, offering a discussion of the methodological issues pertinent to the "theory of the nrm" and of the concepts basic for the analysis of sellers' competition, is followed by six. parts whose titles indicate the system of organization of the analysis: l:'Many Sellers," l:l:More Sellers," l:'Many and More Sellers," "Few Sellerst l:'Few but More Sellers," and "One Seller." That the last part, on "One Seller," consists of only one chapter, while the part on "Few Sellers" extends over five chapters, will probably be found to be indicative of my judgment of the relative importance of the respective topics. The relationship of the present book to some of my other actual, planned, or announced publications on the subject of competition and monopoly may be brieHy explained. This book, together with its companion volume, published under the title The Political Economy of Monopoly: Business, Labor and Government Policies, takes the place of the previously announced book "On the Economics of Competition and Monopoly." Questions of governmental economic policy with regard to monopoly and competition, the institutional sources of monopoly power, the various types of monopolistic business practices, the effects of monopolistic wage policies, the attempted measurements of the degree of business monopoly, and several other issues concerning the political economy of monopoly are discussed in the companion volume. The present book is confined to the economic theory f competition in selling, though it cannot cover all of it: for example, the analysis of discriminatory pricing is deferred to a separate book on "The Economics of Price Discrimination," planned for publication in future years. Some sections of the present book have been published elsewhere. Large parts of Chapters 2 and 3 were contained in myarti.. cle on l:'Marginal Analysis and Empirical Research," published in the American Economic Review, Vol. XXXVI (1946), pp. 519554. An Italian translation of the bulk of Chapter 4 was published under the title l:'Tipi di concorrenza nella vendita" in the Giornale degli Economisti, Vol. XIX (New Series Vol. III, 1941),pp. 129150. Most of Chapters 7 and 8 was published as an article under the title "Competition, Pliopoly and Profit" in Economica, New



Series Vol. IX (1942), pp. 1-23 and 153-175. A part of Chapter 10. is being published in a German .translation under the title "Volkswirtschaftliche Scheinverluste ,beimZustrom neuer Wettbewerber," in Ordo, Vol. V (1952) . Chapter 11 was published as an article entitled "Characteristics and Classifications of Oligopoly," in Kyklo8, Vol. V (1952), pp. 145-1Sg; and a section of Chapter 13 under the title "Oligopolistic Indeterminacy" in the Weltwirtschaftliches Archiv, Vol. 68 (1952), pp. 1-19. The number of my intellectual creditors is too great to permit a full accounting of my indebtedness. But it would be most ungrateful not to acknowledge the great impact on my thinking of the writings of Joan Robinson, EdwardH. Chamberlin, and Frank H. Knight. Footnote references to their published work, however numerous, cannot possibly suffice to show how much of theirs reappears in this book. In the development of my views on methodology lowe much to Alfred Schutz, social philosopher of the New School of Social Research. For friendly criticism of earlier parts of my manuscript I am indebted to John D. Sumner, of the University of Buffalo, who read Chapters 4 to 10; Arthur Smithies, of Harvard University, who read Chapters 6 and 7; and a good many students in my courses at the University of Buffalo, Stanford University, and the Johns Hopkins University. My greatest debt is to Edith Tilton Penrose, of the Johns Hopkins University, who read the entire manuscript and suggested countless improvements. I also acknowledge gratefully financial aid, for editorial and clerical expenses, from the Lessing Rosenthal Fund for Economic Research at the Johns Hopkins University.FRITZ MACHLUP

Baltimore, Maryland, July 1952

Table of ContentsAUTHOR'S PREFACE



ChapterPART I-THEORY OF THE FIRM AND TYPES OF COMPETITION Model Analysis and Observation: Prices and Costs The Theory of the Finn: Marginal Analysis of Prices, Inputs, and Outputs . The Practice of the Firm: Empirical Evidence and Counter-Evidence Types of Competition in Selling Appendix: Types of Competition in Buying PART II-MANY SELLERS






5. Perfect and Imperfect PolypolyAppendix: Marginal Revenue and Elasticity of Demmd 6. Polypolistic Nonprice Competition and Other Forms of Non-Perfect Polypoly PART III-MORE SELLERS 7. Pliopoly: Newcomers to a Profitable Industry 8. Pliopoly: Profits, Rents, and Artificial Scarcity PART IV-MANY AND MORE SELLERS 9. Polypoly and Pliopoly Combined, When Both Are Perfect 10. Polypoly md Pliopoly Combined, When Either or Both Ar~ Imperfect PART V-FEW SELLERS



211 242

273 300 347368

11. Characteristics and Classifications of Oligopoly 12. Classical Duopoly Theories and Their Modem Extensions[ix ]



Chapter 13. Oligopolistic Indeterminacy and Collusion 14. OligopolisticNonprice Competition and Price Rigidity 15. Organized Oligopoly, Leadership Oligopoly, Unorganized OligopolyPART VI-FEW BUT MORE SELLERS


449 475 517 543 567

16. Oligopoly and Pliopoly CombinedPART VII-ONE SELLER

17. MonopolyINDEX

Analytical Table of ContentsChapterPART I-THEORY OF THE FIRM AND TYPES OF


1. Model Analysis and Observation: Prices and CostsA Note on ModeZ AnaZysis:Abstractions, Constructs, Models Theoretical and Descriptive Economics Models .in the Theory of. Price The Economy, the Industry, the Firm: The Selection of Models The Comparison of Prices The Profits of Enterprise The Lack of Actual Price and Cost Data: The Selling Price The. Dating of the Data Total Cost of Production . The Average Cost of the Actual Output . The Marginal Cost of the Actual Output . Hypothetical Price and Cost Schedules


2. The Theory of the Firm: Marginal Analysis of Prices, Inputs, and OutputsConduct Models of. the .Firm . The Marginalist Way of Thinking . The "Determination" of Prices, Output and Input . Subjectivity. of Cost and Revenue The Omission of Important Variables The Range of Price and Output Variations The Time-Range of Anticipations The Numerical Definiteness .of .the Estimates The "Extreme Difficulty of Calculating" . The Analysis of Change Needs no Exactness Non-Pecuniary Considerations Maximum Profit versus Security Maximum Profit versuS Most-Favored Odds

3. The Practice of the Firm: Empirical Evidence and Counter-EvidenceEconomists' Vocabulary and Business. Language Rationalizationsof Decisions or Actions . Averaging Fluctuating Costs and Prices . Actual versus Potential Average Costs. Average-Cost Pricing as the Lawyer's Ideal Average-Cost Pricing as the Accountant's Ideal . Average-Cost Pricing as a Cartel Device Average Cost as a Clue to Long-Run Demand. Elasticity Reasons and Variables Research on Actual Pricing Methods The Absence of Numerically Expressed Estimates The Evaluation of Empirical Evidence[ xi ]






. A Re-evaluation of the Claims Who Can Afford to Pass Up Profits? . The Break-Even Chart Theory and Practice

4. Types of Competition in SellingCompeting Connotations of f:f:CompeUtion": Qualifying Adjectives . Competing Goods and Competing Sellers The Seller's Methods of Getting Business The Buyer's Choice of Sellers Polypoly: A Seller Among Very Many The Polypolist Without Choice of Prices . Horizontal Demand Curves . Pure Competition and Its Synonyms . The. Polypolist with a Choice of Prices . Illustrations . Tilted Demand Curves " Limited Sales Opportunities for Differentiated Products Oligopoly: The Seller Conscious of Rivals' Reactions . OneWay Demand Curves To Watch and To Be Watched" Many, Few, Two, One Pliopoly: Many Sellers and More Sellers . Contrasting the Logical Nature of the Concepts Pre-Conditions of Newcomers' Competition . Entrance and Exit The Seller Conscious of Potential Newcomers Monopoly: The Seller Without Competitor " The Demand Curve for the Monopolist's Product No Entry Perfect Market: Perfection of a Market." Comparison of the Concepts ." Knowledge Accessibility" Absence of Restrictions." Reservation Prices " The Comparison of the Concepts Resumed Summary: Different Classifications


Appendix to Chapter 4. Types of Competition in BuyingPolypsony: Perfect Polypsony " Imperfect Polypsony Oligopsony: The Supply as Seen by the Rival-Conscious Buyer . Illustrations Pliopsony: TheProfitable Industry Monopsony: Three Criteria .. Each Firm Deals in Many Markets,





5. Perfect and Imperfect PolypolyThe Characteristics of Polypoly: The Criteria ,Three Reminders Perfect Polypoly: The Volume of Output under Perfect Polypoly . Two Problems: Subjectivity and Time . The Volume of Output and the Size of the Firm .. The Size of the Firm under PerfectPolypoly Imperfect Polypoly: The Volume of Output under Imperfect Polypoly . Restricted Production . The Size of the Firm under Imperfect Polypoly Transport Costs: Differentiation through Transport Costs Centralized Market Location and Competitive Position Transport Cost and Plant Size


Appendix to Chapter 5. Marginal Revenue and Elasticity of Demand 6. Polypolistic Nonprice Competition and Other Forms of Non-Perfect PolypolyPolypolistic N onprice Competition: Institutional Pricing Factors '. Oligopolistic Considerations . Competition Invigorated or Weakened Standardization, Differentiation, and Price Maintenance The Degree of Competition through Quality Differences Polypolistic Quality Competition: The "Measurability". of Quality . Quality Determination with Variable Selling Prices. Quality Determination and Demand Elasticity The Effects of Improvements upon Demand Quality Determination with Fixed Selling. Prices Polypolistic Competition Through Selling Effort: Selling Effort vs. Improved Quality Relationship Between Selling Cost and Demand . The Effect of a Given Selling Effort . Variable Selling Efforts and Variable Prices . Selling Costs vs. Production Costs Determination of Selling Effort with Fixed Selling Prices Quasi-Perfect Polypoly: The Limitof the Horizontal Range . The Causes of the Horizontality . The Demand for the Product of the "Follower" . Unlimited Offers to Purchase

159 161



ChapterThe Rise or Decline of Polypoly: Empirical Findings Growth of Size of Firms and. Markets Imperfect Polypoly and General Equilibrium: Price and Sales Expectations . Objective Changes and Subjective ExpectationsPART III-MoRE SELLERS

7. Pliopoly: Newcomers to a Profitable IndustryThe Nature and Prerequisites of Pliopoly: The Distinctions Recapitulated .The Pre-Conditions Summarized The Industry: Limiting the Scope of Interdependence . The Boundaries of the "Industry" Profit: Business Profit .versus Economic Profit Transitory and Long-Run Profits . Fixed Resources and Normal Profit . Supernormal Profits and Entry . Subnormal Profits and Exodus Entrepreneurship and Uncertainty: The Quality. of Entrepreneurship . Managerial Services . Uncertainty . The SafetyMargin in Profit Estimates Indivisibility and Immobility: Indivisibility Indivisibility and Uncertainty Combined Immobility Profits versus Imputed Rents The Case of Cheap Resources


8. Pliopoly: Profits, Rents, and Artificial ScarcityAdvance Calculations of Profits: Rents and Profits, Ex .Ante and Ex Post. Discrepancies in Profit Calculations . The Relevant Profit Calculations Advance Calculation and Prospectus Accounting and Economic Concepts Costs, Rents, and Profits: The Distribution of Total Revenue . Profits as Seen by Outsiders, Insiders, and Economists Supernormal Profits and Their Causes: Positive Profits Seen by the Outsider . No Profits Seen by the Outsider . The Economist's Dissenting Calculation . Monopoly Rents in the Form of Factor Costs Artificial Scarcity: Natural and Artificial Scarcity . Monopolistic Barriers





9. Polypoly and Pliopoly Combined, When Both Are PerfectGroup Equilibrium and Marginal Units: Simultaneous Equilibria Different Meanings of Marginal . Perfect Polypoly and Perfect Pliopoly: Maximization and Equalization of Profit Rates . The Danger of Equivocation . The Adjustment of Price Expectations A 'Model Sequence of Price Adjustment . The Dispersion .of Expected Prices During Transition Periods The Adjustment of Cost Conditions . Average Cost Inclusive of Rent The Transformation of Implicit Rent into. Money Cost Capacity Output and Optimum Size: Lowest-Cost Output and Size of the, Firm Quasi-Rent and Scarcity Rent



Polypoly and, Pliopoly Combined, When Either or Both Are ImperfectPerfect Polypoly and Imperfect Pliopoly: Concrete Examples and Theoretical Models Excessive Size and Excessive Outputs Imperfect Polypoly and Perfect Pliopoly: Under-utilized Capacity in an Undersized Firm Price, Cost, and Sales Expectations The Adjustment of ,Sales Expectations . The Predicted Equilibrium Position ,Excess Capacity under the Tangency Rule: The Four Interpretations ,. The Limits of Applicability The Differential Rent of Differentiated Polypolists . Implications Concerning Unused Capacity and Potential Economies The Wastes of Newcomers' Competition: Product Variety at Higher Cost Nine Reasons for Higher Cost of Smaller Scale The Significance of the Nine Points Three Other Reasons of Higher Costs . Weighing the Losses and Benefits Imperfect Polypoly and Imperfect Pliopoly: Product Differentiation asa Barrier to Entry A Common Cause for Both Imperfections . Political Interference with Entry The Effects upon Total Output Low Price Policy to Prevent Entry





11. Characteristics and Classifications of OligopolyTerminology . The Characteristics, of Oligopoly: The Monopoly Power of the Oligopolist, The Many and' the Few Objective Cir . cumstances Behind Subjective Attitudes' . The Emphasis on Price Policies . The Oligopoly Demand Curve . Split Personality Classifications of Oligopoly: ,Alternative Principles of Classification The Degree of Coordination Fight, Truce and Peace


12. Classical Duopoly Theories and Their Modem Extensions.Classical Duopoly Models: Mathematics, Geometry, and English . Assuming a Market Demand Schedule The Cournot Model The Bertrand Model The Edgeworth Model Comparisons of the Classical Models: Prices and Production . Expected Reactions of Rival . Own Reactions to Rival . Summary of Comparisons . Uniformity of Market Prices Buyers' Indifference versus Inertia Extensions of the Classical Models: Modifications of Assumptions . Product Differentiation The Shape and Similarity of' Cost Functions . Asymmetry of Attitudes Guessing Definite Countermoves '.Quasi-Collusive Behavior Patterns More Variables: Product Quality and Sales Promotion . More Than Two 'Sellers


13. Oligopolistic Indeterminacy and CollusionOligopolistic Indeterminacy: The 'General Meaning of Indeterminacy Pure and Applied Economics Anonymous Masses and' the Conduct of Individuals . Extra-Economic Factors Position, Security, and Profit Military Strategy and Games of Strategy . The Strong Sparing the Weak The Forms and Degrees of Collusion: Coordination, Collusion, Cooperation . The Rationale of Collusion . The Degrees of Collusion The Forms ,of Collusion Implicit Agreements to Agree, and Other Quasi-Agreements The Comprehensiveness of Collusion




ChapterOligopoly and General Equilibrium: Polypolistic and Oligopolistic Expectations - The General Equilibrium Model

14. Oligopolistic Nonprice Competition and Price Rigidi~ Oligopolistic Nonprice Competition: The Nonprice Variables - Some Important Distinctions Limits to the Practice of NonpriceCompetition -The Significance of Oligopolistic Quality Competition Determination of Outlay for Nonprice Competition ~9

Oligopolistic Price Rigidity: The Concept of Price Rigidity ~neral Causes of Price Rigidity Reasons Applying to Oligopoly Only The Kink Theory of Price Rigidity

15. Organized Oligopoly, Leadership Oligopoly, Unorganized Oligopoly "" "proxunation to Monopoly Polley The Policy of a Syndicate o The Policies of a Price Cartel and Its Members "Member's Conduct under Given Cartel Rules Member's Conduct With an Eye to Renegotiations - The Theory of Cartel Negotiations The Cartel Government0

Org~nize~ Oligopoly: Types .of Organize~ Oligopoly oAp-


Leadership Oligopoly: Different Concepts of Leadership The Qualifications of the Leader .. "Partial. Monopoly" and cCPartial Oligopoly" Rotating and Divided Leadership

Unorganized Oligopoly: Unorganized Cooperation Types of. Uncoordinated Oligopoly . Fighting Oligopoly HyperCompetitive Oligopoly . Chain Oligopoly Guessing-Game OligopolyHistorical Trends: Speculative Clues Historical Clues




16. Oligopoly and Pliopoly Combined

. " 517

Combined Effects ana Interaction: Pliopoly Affecting Oligopoly Oligopoly Affecting" Pliopoly Free Entry, Gluts, and Oligopolistic Control: Free Entry Without Entrants Cartels as Children of Depression Restriction Warranted in Overexpanded Industries?





Oligopoly, Entry, and Excess Capacity: Cartels in Open Industries . Mergers and Concentration in Open Industries . The Essential Differences The Threat of Potential Competition: How to Keep Them Away Sacrificing Short-Run Profits Sectional and Chain OligopolyPART



17. MonopolyThe Characteristics .of. Monopoly: The Definition c'Pure Monopoly" . Cross-Elasticity of. Demand Instances of Monopoly The Absence of Pliopoly: Temporary versus Lasting Positions . Natural versus ArtificialObstacles . Subjective versus Objective JudgmentsL~ng-Range Monopoly Policies:. Perfect Monopoly and the Confident .Monopolist . Non-Profit Objectives


8.hort-Range Monopoly Policies: The Pessimistic Monopolist . Pessimism, Optimism~nd Progress l"fperfect Monopoly: Potential Competition' Distinctions and Differences . Potential Government Sanctions and Organized Reaction . Restraints Due to Bilateral. MonopolyJoin~

Supply, Related Demand, Di$orimiruitory Pr.icing




I.. Imperfect Polypoly, Price and Quality Competition II. Perfect Polypoly, 'Choice among Standardized Qualities, Saleable in Unlimited Quantities at Given Differential Prices III. Imperfect Polypoly, Price 'and' Quality Com~, petition IV. Imperfect Polypoly, Quality Competition' at a Fixed PriceTHE EFFECT OF A GIVEN SELLING EFFOI\T

2 3

172 174 176



I. Sales Opportunities at Various Prices With and Without Selling Campaign II., Effects of Selling Effort on Demand Prices and Quantities Demanded III. Dynamic or Time-Sequence Analysis of ~ffects of Selling Campaign IV. Demand as 'Schedule of Maximum Prices or Maximum Quantities Obtainable by Any Sequence of StepsDEMAND PRICES NET OF SELLING COSTS

'67, '8 9

186 187188



I. Alternative Selling, Prices With Different Selling Costs and Resulting Average Net, Revenues II. Maximum Average Net Revenue or Demand Prices .With the Cost of Optimal Selling Techniques 'DeductedPERFECT POLYPOLY AND PERFECT PLIOPOLY




Tangency of Horizontal Demand Curve Wjth Average Cost Curve[xix 1





Fig. Page

Tangency of Increased Demand Curve With Average Cost Curve Secured Through Rent IncreaseCOST OF PRODUCTION WITH DIFFERENT SIZES OF



FmMThe Long-Run Cost Curve as a Composite of All Short-Run Cost CurvesPERFECT POLYPOLY AND IMPERFECT PLIOPOLY



No Tangency of . Horizontal Demand Curve and Average Cost CurveIMPERFECT POLYPOLY AND PERFECTPLIOPOLY



Tangency of Sloping Demand Curve With Average Cost CurveMONOPOLISTIC UNDER-UTILIZATION AND MONOPOLY PROFIT



Imperfect Polypoly With Excess Capacity Depending on Interpretation of RentIMPERFECT POLYPOLY AND IMPERFECT PLIOPOLY



No Tangency of Sloping Demand Curve With Average Cost CurveOLIGOPOLY AND KINKED DEMAND CURVES



Price Insensitivity to Changes in Cost or Demand 20, 21, 22CONDUCT OF A CARTEL MEMBER


I. Total, Average, and Marginal Revenue of a Secret Price Cutter II. Output Reduction Due to Sanctions for Excess SalesPARTIAL MONOPOLY WITH SMALL COMPETITORS

23 24

483 485

Elasticity of Demand for Large Firm's Output Increases With the Size and Elasticity of Supply from Small CompetitorsIMPERFECT MONOPOLY



A Price Zone Safe From Competition Bordered by Zones of Potential Competition






Model Analysis and Observation: Prices and CostsA Note on Model Analysis: Abstractions, Constructs, Models Theoretical and Descriptive Economics Models in the Theory'of Price The Economy, the Industry, the Firm: The Selection of Models The ' Comparison of Prices The Pronts of Enterprise The Lack of Actual Price and Cost,Data: The Selling Price The Dating of the Data Total Cost of Production The Average Cost of the Actual Output The MarginalCost of the Actual Output Hypothetical Price and Cost Schedules


certain aspect,s of human a,ction',eco,nomists do not look at the "whole man" but rather at man as consumer, ,worker" employer, tenant, landlord", saver, 'investor, buyer, seller. This book deals only with the seller, indeed only. with the"seller for profit." The seller for profit is customarily called a business firm" and the analysis of sellers' conduct is usually treated under the heading "theory of the firm," although this is a rather big name for so narrow anaspe,ct of,business behavior. We shall have a'good deal to say in these early chapters about the deliberate narrowness of the theory of the firm as a part of the "theory of relative pi-ices" and, of the "economics of competition ,and monopoly." , "Price" and "selling" are concepts that necessarily go together: there can be no sale without a price, and there can be no price with~ out a sale-at least, without a sale in mind. Economic analysis of selling prices., calls for comparisons bet\Veen different. prices and for comparisons of prices with "costs~" Costs and prices are indispensable data in any theoretical or empiri