Revival: The Megacorp and Oligopoly: Micro Foundations of Macro Dynamics (1981)

Micro Foundations of Macro Dynamics

Alfred S. Eicher

• Publisher: Routledge
• Year: 2017
• Print ISBN:
  9780873321686
• eBook ISBN:
  9781351696739
• Topic: Politics & International Relations
• Subtopic: Politics
• Index: Politics & International Relations

This title was first published in 1976. This book provides both an explanation of the inflation which has bedeviled economic policy in the West since the end of World War II and a micro-economic theory to purge Keynesian models of the Walrasian strain derived from Marshall's Principles. By focusing on what is taken to be the representative business firm of the twentieth century - the large corporation or megacorp - the microeconomic model presented in the book reverses the usual assumptions of economic analysis. Instead of assuming the existence of firms with no control over prices, the book examines how the megacorp uses its pricing power to finance its own internal rate of growth. The result is a determinant model of how prices are set under the sort of oligopolistic conditions which prevail in most modern industries throughout the world.

1. Introduction

The purpose of this volume is to provide a theoretical understanding of how prices are determined in the oligopolistic sector of the American economy and how those prices, so determined, affect the growth and stability of the economy as a whole.

The need for such an understanding would appear to be unquestionable. Persistent inflation in the period after World War II, manifested as a continuing rise in the various price indexes, has thwarted the application of the Keynesian insights to assure steady economic growth at full employment. In the process the pre-war business cycle has been replaced by what Joan Robinson (1962b), following Michal Kalecki (1943), has termed the political trade cycle. This involves the deliberate suppression of aggregate demand by the government, once high levels of employment have been attained, to meet the complaints of rentier groups that the value of the dollar is being eroded - followed by the deliberate stimulation of the economy, once the rise in the price level has been halted, to calm fears of spreading unemployment. Forced to choose alternatively between full employment and price stability, the government has been unable to achieve either with consistency.

Why the American economy should find itself caught on the horns of this Phillipsian dilemma cannot be adequately explained by recourse to the existing body of economic theory.¹ While one might expect on the basis of this theory that prices would rise if aggregate demand should grow more rapidly than aggregate supply, one would not anticipate that prices would remain constant or even continue to rise if aggregate demand should begin to decline. This is because in the conventional pricing models there is nothing to suggest that the industry supply curve is not positively sloped. A decline in aggregate demand and, pari passu, a decline in the demand for any particular industry's product should, according to the existing body of theory, lead to a fall in industry price levels. Yet, as recent experience reveals, prices do remain constant and even on occasion continue to rise when aggregate demand begins to decline.² Meanwhile, the American government, like the political authorities in other Western nations, continues to rely almost entirely on monetary and fiscal policy for dealing with inflationary pressures, despite the fact that the efficacy of these instruments derives solely from their ability to affect the level of aggregate demand. Thus the failure of public policy can be traced more basically, as Keynes suggested in another connection, to the failure of theory. In this case, it is the failure of theory to provide an adequate explanation of the inflationary process or to suggest some means of bringing it under control without, at the same time, sacrificing the growth of real output.³

The failure of theory can be traced, in turn, to the lack of a suitable pricing model for the type of industry which plays such a prominent role in the American economy. This type of industry is what is known as oligopoly. While superficially it is the fewness of the sellers that is the essential characteristic, actually it is the recognized interdependence to which the fewness of the sellers gives rise that sets oligopoly apart from other types of market structure. What this means is that no single member of the industry can expect to take action without evoking a response from the other firms which are its rivals.⁴ Considered as a whole, the industries which evidence this prerequisite interdependence constitute the oligopolistic sector of the American economy, a delineation which cuts across manufacturing and similar sectoral lines. As one of the underlying themes of the present work, it may be stated that not only is it essential to make a distinction between the oligopolistic and non-oligopolistic sectors of the economy but that, in addition, the former gives rise to a pricing dynamic which is a significant source of autonomous inflationary pressure.

The dynamic derives from the substantial market power - or pricing discretion - which the firms in the oligopolistic sector possess and from the interaction between these firms and certain trade unions which results in the establishment of the national incremental wage pattern. Implicit in the oligopolistic pricing model which forms the core of this work is a cost-push explanation of the inflationary process - with equal emphasis on wage and profit factors - that supplements the more generally recognized excess-demand theories.

The purpose of this volume, then, is to provide a valid micro foundation for Keynesian - and post-Keynesian - macroeconomic theory.⁵ The aim is to make it unnecessary to rely on the neo-classical model for microeconomic analysis, thereby removing a major source of the resistance to Keynesian ideas. This purpose is accomplished, first by developing a model based on assumptions that more accurately reflect conditions in the oligopolistic sector and, second, by relating the variable to be explained to the same key determinant as that found in the basic Keynesian system. In the oligopolistic pricing model that follows, a change in the industry price level is held to be a function, costs remaining constant, of a change in the rate of growth of investment relative to the rate of growth of internal funds generation. Put another way, prices in the oligopolistic sector are set not to maximize short-run profits but rather to enable the firms in that sector to finance the level of investment necessary to maximize - or at least move further toward maximizing - their own long-run growth. It is this crucial link between the pricing decision and the investment decision which, among other things, sets this oligopolistic model apart from others.

Aside from its greater compatibility with the Keynesian system, the pricing model developed here has several other important characteristics. For one thing, as already alluded to, it is predicated upon realistic assumptions, that is, assumptions descriptive of actual conditions in oligopolistic industries. These assumptions, justified more fully in the next chapter, pertain to the representative firm in the oligopolistic sector, a firm which, for communicative convenience, shall henceforth be referred to as a megacorp. The assumptions made about the megacorp are threefold: (1) that it is characterized by a separation of management from ownership, with the effective decision-making power residing in the former; (2) that production occurs within multiple plants or plant segments, the factor coefficients for each of these plants or plant segments being fixed due to both technological and institutional constraints, and (3) that the firm's output is sold under conditions of recognized interdependence, the members of the industry engaging in what has been termed 'joint profit maximization'.⁶ Each of these assumptions is of critical importance analytically. The first bears on the motivation of the firm, determining the behaviorial rule that will be followed for pricing decisions; the second assumption bears on the shape of the megacorp's cost curves, determining the incremental expense incurred over the relevant range of output, and the third assumption bears on the nature of the megacorp's revenue curve, or function.

Another important characteristic of the model developed here is that it leads to a determinate solution. It is this determinateness, together with the realistic nature of the underlying assumptions, which makes the model unique. On the one hand, other models which also provide a determinate solution, such as the classical Cournot duopoly model, lack realism. They are based on premises that either contradict the behavioral definition of oligopoly or are in some other crucial aspect incompatible with observed conditions.⁷ On the other hand, previously available models which are realistic, such as the frequently employed percentage markup or cost-plus model, are indeterminate. They lead to a multiplicity of possible price levels (R. Hall and Hitch, 1939; Lanzilotti, 1958). Falling somewhere between these two polarities is the 'game theory' approach. Whatever its merits, this approach has so far failed to produce a model of oligopolistic pricing that is both determinate and realistic.⁸

The determinateness of the oligopolistic model presented below in chapter 3 is, however, of a special type. First, the solution is discernible only from the long-run perspective of the industry as a whole, with one megacorp, the price leader, acting as surrogate for all the members of that industry. As long as the focus remains either on the individual firm acting independently and/or on the short-run situation, the price in an oligopolistic industry will continue to appear indeterminate. Second, what is determinate from the long-run perspective of the industry as a whole is not the absolute price level but rather the change in that price level from one time period to the next. Thus the price in an oligopolistic industry can be understood only in terms of the marginal adjustment that occurs with respect to a historically established figure.

That marginal adjustment, however, is fully determinate within the hypothetical model. The price leader, on behalf of the industry, will vary the industry price so as to cover (1) any change in per unit average variable and fixed costs, and (2) any increased need for internally generated funds. Whether additional internal funds are needed will depend on the prospective return from the investment of those funds relative to the real costs incurred should the industry price be increased. These real costs, which serve as the effective restraint on the pricing power, or discretion, of the megacorp, derive from three sources: (a) the substitution effect, that is, the loss of market to substitute products as the relative price rises; (b) the entry factor, that is, the probability of new firms entering the industry as the absolute price rises, and (c) the fear of meaningful government intervention, that is, the probability of action by public authorities to impair the long-run growth prospects of the megacorp. From these costs it is possible to derive the equivalent of an interest rate, it then being possible to compare this implicit interest rate on internally derived funds with not only the megacorp's own marginal efficiency of investment but also the cost of external funds. Any resulting change in industry price will be one that is designed to maximize the long-run growth of the price leader - if not the other megacorps in the industry - by providing the price leader with an optimal quantity of internally generated investment funds.

The oligopolistic pricing model developed here is thus an elaboration of the cost-plus model cited so extensively in the survey literature with one crucial refinement. The 'plus' in the cost-plus formula - why it varies both over time and among industries - is fully explained (Eichner 1973a). In the course of explaining this 'plus' item, the model builds on the earlier work of Baumol (1967) and Marris (1964) as to what motivates the megacorp's executive group and on the previous work of Bain (1949) and Sylos-Labini (1962, part 1) as to how potential entry affects the pricing decision. The precise relationship between the present work and these earlier efforts to explain oligopolistic pricing behavior is spelled out in separate appendixes to chapters 2 and 3. At the same time, the analysis points out the irrelevance of the conventional Chamberlin-Robinson monopoly model insofar as oligopoly with homogeneous products is concerned (Chamberlin, 1962; J. Robinson, 1969), it being shown that if there is to be a determinate price in such an industry, with the elasticities of demand actually observed in the oligopolistic sector, it will almost certainly reflect the unexercised monopoly power which Galbraith (1957) has on occasion pointed to (see also Galbraith 1952, 1967a). But this 'unexercised monopoly power', rather than indicating the type of satisficing behavior postulated by Simon (1955) and Cyert and March (1956, 1963), is instead simply one of the factors which, more appropriately termed the substitution effect, determine the shape of the megacorp's supply curve for internally generated funds - the latter being the analytical device for linking the pricing decision to the investment decision.

Once developed to fit the simple case of a megacorp-price leader which is a member of but a single oligopolistic industry, the model can be altered and extended to cover other types of enterprises, including the unregulated monopolist, the regulated monopolist and the conglomerate or multi-industry firm. By assigning the proper values to certain of the key variables as well as by making certain other modifications, even the perfectly competitive - or polypolistic⁹ - firm can be analyzed within the same general framework. The effect is to cast in a somewhat different light the pricing model which has until now dominated microeconomic theory. These alterations and extensions of the basic oligopolistic model are described in chapter 4.

To complete the reformulation of microeconomic theory, it is necessary only to supplement the oligopolistic pricing model with an explanation of factor pricing or, viewed differently, the distribution of income within the megacorp. For this purpose, because of the fixed nature of the technical coefficients - at least in the short run - the traditional marginal productivity approach is irrelevant. Instead it is necessary to adopt an alternative approach, one that combines the institutional economists' emphasis on power relationships and the sociologists' focus on societal norms with the Marxian theory of surplus value, the Keynesian stress on aggregate demand factors and the linkage between the secular growth rate and the savings propensities of different groups brought out in post-Keynesian macrodynamic models.¹⁰This is done in chapter 5. There, in a return to one of the themes brought out in chapter 2, the megacorp is viewed as being confronted by various constituencies whose claims against its revenue are mediated by the executive group. The two most important of these constituencies are (1) the members of the laboring manpower force, a significant proportion of whom, it is assumed, are represented in collective bargaining by one or more trade unions, and (2) the equity debt or stockholders. The latter, it should be emphasized, serve as rentiers rather than as the recipients of the residual income share. They differ from the other constituent groups only insofar as the legal conventions enable them to bring to bear certain unique forms of pressure vis-á-vis the executive group. Since this view of the megacorp's nominal owners permeates other chapters as well, the entire treatise can be included among the growing body of managerial theories of the firm.¹¹

The theory of income distribution developed in chapter 5 suggests that, as a result of practices that have evolved over time, the compensation received by the megacorp's other constituencies, including the equity shareholders, is geared to that obtained by the organized portion of the laboring manpower force, This means that the trade union, in bargaining for its own members, is in effect putting forth the claims of all the households dependent on the megacorp for income. The trade union, in turn, is likely to insist upon - and the megacorp to grant - that increase in compensation which has, in a social sense, been deemed 'fair and reasonable' through the mechanism of the national incremental wage pattern. This pattern can be established in a number of different ways, as the practice of other countries attests. In the United States it most typically arises from the 'key' collective bargaining agreement negotiated in one of the major industries, usually steel or automobiles, often only after Presidential intervention with its implicit socio-political sanction. In a period of active government involvement in the economy, the agreement negotiated in the 'key' industry may have to obtain explicit sanction from a Presidentially-appointed tripartite board. This, of course, was the case under the anti-inflationary program announced by President Nixon in the fall of 1971 and later endorsed by Congress. But it should be noted that the same was true during World War II and the Korean conflict.

Thus the increase in compensation obtained by the megacorp's principal constituencies - and a fortiori any increase in per unit costs - will depend, time lags aside, on the national incremental wage pattern established at the macro level. What in effect is determined in that key bargain is the nominal division between the household and business sectors of that portion of the current national income not already commandeered by government. The key bargain therefore represents the first step in the allocation of resources in the private sector between present and future consumption. In Marxian terms, the issue with which the key bargain is concerned is the disposition of the incremental surplus value created by individual megacorps, this incremental surplus value in the aggregate constituting the marginal social surplus arising in the oligopolistic sector. Any increase, either in wages or dividends, represents an apportionment of part of that incremental surplus value to households.

Yet the issue is not fully resolved, even after other trade unions have forced the megacorps with which they bargain collectively to grant increases in compensation equal to the national incremental wage pattern. For after the nominal wage rate has been agreed to, and per unit costs as a result determined, megacorps still retain the power to alter the various industry price levels and thereby, unconcertedly but none the less effectively, fix the real wage rate. With the theory of income distribution provided in chapter 5, it is possible to go on and explain in chapters 6 and 7 this process by which the real wage rate is determined - at least within the oligopolistic subsector of the economy. Chapter 6 uses the microeconomic base developed in the earlier chapters to sketch the outlines of a macrodynamic theory. Among the important points brought out are the following:

1. Because of the behavioral principle followed by the megacorp, investment within the oligopolistic subsector depends primarily on the expected rate of growth of industry and, pari passu, of aggregate demand. The oligopolistic pricing model which forms the core of this volume thus lends theoretical support to the accelerator model of investment now increasingly employed by empirical investigators - and in particular to the lagged industry sales version of that model developed by Eisner (1963, 1967). This model contrasts sharply with the determinants of investment in the competitive subsector, as well as those emphasized in economics textbooks.

2. With the oligopolistic sector in fact accounting for most of the private investment actually undertaken, the savings-investment equilibrium adjustment process needs to be reformulated. Assuming household savings to be relatively constant and only a minor contributor, in any case, to capital formation in the business sector, it follows that the critical savings decisions are those made by megacorps. These decisions are reflected in the margins above contracted costs at which price levels in the oligopolistic sector are set. Thus, as in the pre-Keynesian schema, the decisions of how much to save and how much to invest are in the hands of the same party. However, because the price levels must necessarily be set on the basis of expected sales volume - forecasts of which are subject to considerable error due to fluctuations in aggregate demand - the possibility of ex ante and ex post savings diverging, at least within the oligopolistic sector, nevertheless remains.

3. Given the first two propositions, a post-Keynesian macrodynamic model along the lines first set forth by Robinson (1956, 1962a) and Kaldor (1957) then emerges (see also Kaldor and Mirrlees, 1962). The model follows the earlier work in almost every important respect, including the assumption of a flexible savings ratio and the rejection of a neo-classical production function. The one significant modification is that the flexibility of the savings ratio hinges, not on a presumed difference in the marginal propensity to consume out of wages and out of profits - and the effect that this difference has on aggregate savings as the share of national income accruing to property owners varies - but rather, on the power of megacorps, through the control which they exercise over prices, to alter the savin...

Table of contents

• Cover
• Half Title
• Title
• Copyright
• Dedication
• Contents
• Preface
• 1 Introduction
• 2 The nature of the megacorp
• 3 The pricing decision
• 4 Extensions of the basic model
• 5 The distribution of income
• 6 Micro and macro
• 7 Conventional policy instruments
• 8 Toward social control
• Notes
• References
• Index