Franco Modigliani and oligopoly

Banca Nazionale del Lavoro Quarterly Review, Jun-Sep 2005 by Labini, Paolo Sylos

1. Some personal recollections

I met Franco in 1948 - over half a century ago! - in Chicago, when he was teaching at the University of Illinois, where I had arrived with a research scholarship. He and his wife Serena would often invite me to dinner, and we would go on talking long into the night, until Serena had no choice but to send me on my way. I spent the period from January to September 1949 at Cambridge, continuing in my role as a researcher, and at Harvard came into frequent contact with Schumpeter. I became personally acquainted with Salvemim, who had an office at that University, having taught history there until a few years before. For me he was like one of the family, since my father - a staunch anti-fascist from Puglia - had brought me up to love and admire him. Shortly after my arrival in Cambridge a room became vacant in the cottage where I had found accommodation, and Salvemini moved in; and so it was that every morning I would set out in the company of a 'piece of Italian history', and I did my best to take advantage of the situation preparing all sorts of questions in advance. For his part Franco revered Salvemini, and when he came to Harvard from Chicago on a brief visit I introduced them. From then on they kept up regular if not intensive correspondence. Franco was drawn to Salvemini not only on the intellectual plane, but also at the level of political and social commitment. Franco used to visit Italy every year since Rome was his home town and he had lived there until his first year at university, when he was compelled to emigrate as a Jew: here he had his mother, brother and other relatives, as well as a great many friends.

2. Franco Modigliani's interests as an economist. Oligopoly

Franco's interests as an economist cover five main fields: Keynes and unemployment, monetary mechanisms and real mechanisms, prices and wages, saving and life cycle, and company finance. Naturally, these are not watertight compartments. We shared an interest in these fields, but our main common interest became the third one, that of the mechanisms at work in determining prices and wages. To begin with, there was my book on oligopoly published in 1956, and subsequently revised in the following editions. Franco was favourably struck by it and wrote a review article dealing with both my book and a book that had come out in the same months by Joe Bain entitled Barriers to New Competition. Franco's article, "New developments on the oligopoly front", appeared in the June 1958 issue of the Journal of Political Economy. The overall judgement of my analysis was decidedly positive, and the article prompted the then director of the prestigious series published by the Harvard University Press, John Kenneth Galbraith, to have the book translated and bring it out m the series, which in turn led to invitations and translations of that and other books in various countries. All this I owe to Franco. As was to be expected, he had some reservations about certain points of my analysis in his review. I, too, had some reservations about his interpretation of my model, the main one being that he found in it an essentially static approach with promising leads for dynamic analysis, while I set out to present a dynamic analysis from beginning to end. My analysis of the determination of prices might also be seen as static, but it was designed to prepare the basis for an explanation of variations m prices. Franco embarked on an analysis of price determination in quite an original way, pointing out that his intention was not to offer a faithful account of the arguments set out by Bain and myself, but to develop the logical essence of our approach (Modigliani 1958, p. 402).

The model for the determination of prices and their variations in oligopoly is called the 'full cost', or 'mark-up' model, and is based on the concepts of 'exclusion price' and 'elimination price'. Fundamental for the identification of the levels of these two types of prices is the extension of the market (the volume of sales at a certain price), which is however to be considered together with the absorption capacity of the market itself and the distribution of sales among firms of various sizes. The absorption capacity is given by elasticity of demand, which does not mean the infinitesimal elasticity of traditional theory, but a notion that contemplates finite variations, which I call "empirical elasticity". In an economy that is developing, the extension of the market tends to increase over time, with effects on both firm sizes and costs which in turn play the most important role in the determination of prices and their variations.

These are features of my analysis, while Franco's focuses on the characteristics of the traditional demand curve and disregards development. Moreover, Franco dubbed as "Sylos's postulate" the assumption that, in order to discourage the entry of new firms, the existing firms leave their production unchanged if newcomers enter the scene. It is an assumption in stark contrast with that of traditional theory, which has it that the firms are compelled to cut down on their production if new firms come in: from my viewpoint this is the case in conditions of perfect competition, but not in those of oligopoly. However, it is in any case not the rigid assumption one might expect when the term 'postulate' is brought in: my point is that the assumption applies in certain market conditions - I begin with a market situation 'criée au hasard', considering a certain economic space and a given 'empirical elasticity' of demand - but not in others. Nevertheless, the fact remains that the existing firms do not necessarily adjust production when other firms attempt entry. Between myself and Franco there are no logical contrasts, but different assumptions, and thus different lines of analysis.