MFM(2019-21)

Economics Assignment

SUBMITTED TO: Dr. MANGESH

SUBMITTED BY: SRISHTI KHARB

HOW DOES RECESSION AFFECT FASHION
INDUSTRY?
“Recessions damage consumer confidence, can damage retailers and suffocate brands who
often struggle to make payroll and cover working capital, however, it is important to realize
that there can also be substantial opportunities. Brands and retailers that survive a recession
may emerge with a more engaged and loyal set of customers, fewer competitors, and
additional assets and opportunities.” Sarah Willersdorf, managing director and partner at
the Boston Consulting Group.
The whole world is facing global recession. The economy is slowing, the business
environment is unpredictable and the consumers are getting increasingly diverse, informed,
and technologically strong and demanding. The global meltdown has, in no way, spared the
fashion industry. This industry, along with other textile industry, is also feeling the pinch of
financial adversity.
The apparel industry has the potential to contribute significantly to economic development
due to the scale and the profile of workers employed. Textiles, clothing and footwear are a
large source of formal employment in the developing world. Composed predominantly of
young women, the industry includes a large number of internal migrants, workers on short-
term contracts and low levels of trade union representation. In some countries, garment
manufacturing may be one of the only opportunities to move into the formal sector, and
frequently one of the few jobs considered acceptable for women.
This introductory step on the ladder of industrial development provides women with
opportunities to learn marketable skills and develop financial independence. Conversely, the
shockwaves created by the abrupt removal of one of the few industries that employs
unskilled women is likely to have a negative ripple effect on development.
Global apparel industry supply chains have been the focus for experimentation with new
forms of multi-stakeholder collaboration, involving national and international dialogue and
action focused on labour standards, industry transitions and responsible competitiveness.
This may provide useful foundations for multi-sector responses to the recession and for
sustainable recovery in the industry, as well as potential models for other sectors.

Demand for textile and garments dropped considerably during the past few quarters,
especially in USA, Europe and Japan due to falling consumer confidence and rising
unemployment figures. Many consumers were then focusing on prices and were shifting
demand to lower –priced products and/or postponing consumption. With the exception of
few export oriented nations of clothing –namely Bangladesh and Vietnam most were
suffering from strong reductions.
As industries around the world were adapting cost cutting techniques to survive affect of
recession, the Indian fashion industry was gearing up itself to survive recessions' onslaught.
Designers in Bangalore said that they were now reinventing themselves by making use of
less expensive fabrics to cope with the prevailing downward trend in global economy.
The clothing sector has survived the recession in UK, with the market growing 1.4% in 2009
to £41.3 billion and by an estimated 1.5% in 2010 to £41.9 billion. While growth was limited
due to weakened consumer spending, sales remained in positive territory. The wealthiest
shoppers still bought luxury goods during recession, but there was a pushback against items
with noticeable logos, while more subtle designs gained respect. Some rumors reflected
people’s response that it was suddenly so uncool to look rich.
“People were dripping in gold. There was bling on clothing, jewelry, accessories,” says
Christina Binkley, who covered fashion for the Wall Street Journal. “Fashion had been really
loud and it was a huge party, and then that shifted literally overnight.”
It’s impossible to separate the aesthetics of consumer goods from the economic
circumstances under which they were created. The ways we adorn ourselves and our homes
— and the ways brands dress themselves up to get our attention — speak to our personal and
national relationships with money. Minimalism was also a hallmark of the clothing that came
out of the Recession. Everlane pushed elevated basics, like simple T-shirts and navy
sweaters. Cuyana, a brand launched in 2013, piously encouraged shoppers to buy “fewer,
better things” — not a new impulse in the aftermath of an economic shock. In a 1974 essay
called “Recession Dressing,” a response to an economic downturn that had begun a year
prior, the fashion writer Kennedy Fraser wrote, “The old interest in the cautious principle of
spending more on fewer clothes of better quality is back.”
The alarming number of factory closures and lay-offs reported in the first phase of the
recession exposed the vulnerability of the industry. The pattern of these closures and lay-offs
cannot be explained simply by the drop-off in export demand experienced at that point. As
the trade figures show, the fall in the level of global trade in apparel occurred seriously in
2009. Before that, orders placed earlier in the year were still being fulfilled. However, even
the relatively modest reduction in export growth experienced in 2008 was accompanied by a
more widespread, and largely unexpected, collapse of suppliers and loss of jobs.

"The challenge of course, with everything so turbulent, is how do you really forecast
the demand levels over the next six months, established brands would ride out the
economic storm, but younger designers may not survive. Saks has done particularly
well with Chanel and Louis Vuitton in recent seasons, and is also pleased with the
performance of Christian Dior, It was really tough to add new brands right now , I
feel badly for a lot of these small brands, because they look to the Saks and the
Neimans and the Nordstroms of the world as a launching location,” said Ron Fransch
(president and chief merchandising officer of the upscale department store chain
Saks) .
After the Great Recession, the country’s worst economic downturn since the Great
Depression, it was venture-backed lifestyle startups, not established mega-
corporations, that offered consumers a way forward through design. Direct-to-
consumer lifestyle brands like Warby Parker and Everlane, both launched in 2010,
began selling eyeglasses and sweaters without the retail markup, finding an
uncomplicated aesthetic that suited their values.
Although the origins of recession can be found in the ‘sub-prime’ crisis of late 2007
in the US, the full impacts of recession can be dated to the collapse of the Lehman
Brothers bank in New York in September 2008. One informant in Hong Kong,
sourcing for the lower end of the US garments market, described how US demand
seemed to collapse quite suddenly as credit restrictions tightened sharply and retailers
ran down stocks rather than reordering, although demand recovered considerably by
the spring of 2009 (interview, September 2009). This fall accords with the fact that
industrial production in high income countries dropped by 23% in the last quarter of
2008. Recession, standing on what some believe is the precipice of another recession,
we’re in a position to examine the ways in which it shaped design and led to the
aesthetics of the present moment.However, information on retail garments sales in the
US and Europe suggest the recession was by no means over by the spring of 2009. A
report on the US retail market in late 2009 said half of middle-market retailers had
experienced a fall in revenue over the preceding twelve months (J-S, September
2009). Reports suggested that the all-Europe market for garments would decline by
some 5% in the course of 2009 (J-S, 22 September 2009). It was reported in mid-
September 2009 that London’s retailers (though this is for sales in general, not just for
garments) would be posting their worst monthly results for four years. Moreover,
these brands were personable. Their ad and product copy was friendly and colloquial,
which felt right because they were largely operated by millennials who were targeting
their peers, creating a sense of shared values. There have been different impacts at
different parts of the retail market for garments. For example in the UK market, one
buyer indicated that younger women seem to have hardly curtailed their purchases
whereas older women have done so. Mid-market garments retailers in the US such as
JC Penney and The Gap have reported substantial falls in sales, as has Marks and
Spencer, the UK’s largest retailer of garments. Some mid-market firms, however,
such as Zara (owned by Inditex of Spain) have seen increased sales, though
decreasing profit. 19 But the main gainers amidst the declining overall market have
been at the lower end, the socalled ‘value’ retailers, such as Primark in the UK, and
particularly discount chains such as Wal-Mart in the US (J-S, 22 September 2009).
Industry sources suggest that this is not simply a switch of consumers to cheaper
products in times of economic hardship, but an upgrading of products at the lower end
into more fashionable areas while maintaining low prices. 32 Supermarkets in the UK
and Europe also have been developing sales of garments and sourcing in Asia. Clearly
if the strongest parts of the Western retail market are ‘value’ retailers, there is likely
to be increased downward price pressure on garment and fabric producers. One
consequence of the increased concern with price, following a decade or so when
prices for garments have been under downward pressure in major markets, is a search
for lower cost producers.

Minimalism was also a hallmark of the clothing that came out of the
Recession. Everlane pushed elevated basics, like simple T-shirts and
navy sweaters. Cuyana, a brand launched in 2013, piously encouraged
shoppers to buy “fewer, better things” — not a new impulse in the
aftermath of an economic shock. In a 1974 essay called “Recession
Dressing,” a response to an economic downturn that had begun a year
prior, the fashion writer Kennedy Fraser wrote, “The old interest in the
cautious principle of spending more on fewer clothes of better quality is
back.”By 2014, deliberately plain clothing (fleeces, New Balance
sneakers) had become a full-blown trend in the form of normcore.
IMPACT OF WORKING 35 HOURS A WEEK,
ON ECONOMY
While it is relatively straightforward to impose a maximum number of hours worked in the
week for employees, it is harder to do so for the self-employed and harder still to legislate to
force people to work a four-day week, especially because not everybody could take the same
days off and there would presumably need to be some flexibility about when the hours were
worked. The idea is that working fewer hours would boost productivity, which is the value
created by each hour worked.
Trying to boost productivity by reducing hours worked would not be without its costs.
France has higher unemployment than the UK. It is likely that its more restrictive labour laws
have meant that companies have invested more in machinery to reduce the number of people
they need .The average amount paid worked by full-time employees in the UK in 2016 was
39.2.The UK has comparatively low productivity. The UK's national income per hour
worked is 22.7% below that of France, which means that if we could be as productive as the
French then we could work a four-day week and not lose much output.
Also, a study suggested that the 35-hour week in France had reduced employment and not
made workers any happier.
But it's not just about maintaining economic growth - part of the idea of the four-day week is
that to create a more sustainable economy we need to stop being obsessed by growth and
start thinking about having a lower impact on the environment.
It identified potential problems with the introduction of such a system such as increased
poverty by reducing the number of hours worked by low-paid workers and increased
unemployment. UK employees have the longest working week compared to other workers in
the European Union. But, despite the long hours, recent studies have shown this does not
make the UK a more productive nation.
An analysis by the Trade Union Congress on working hours and productivity found that,
while UK full-time staff worked almost two hours more than the EU average, they were not
as productive as staff in Denmark who worked fewer hours in the average week. Such
findings have triggered an interest in the relationship between the number of hours worked
and productivity – and the results of several studies have suggested the concept of “optimal
working time”. This refers to an optimal number of hours spent at work after which
productivity begins to decline and acute or chronic health problems begin to arise. Some
experts suggest it should be no more than 35 hours a week.
Research on earlier reductions in hours has tended to suggest that productivity rises as a
result of reduced hours. A review of this research concludes that the productivity effect of
reduced hours has been overstated. It also raises some important methodological issues.
So, while the prevalence of flexible working and the use of technologies to facilitate it have
brought many benefits to organisations, such changes have also helped to create a 24/7 work
culture– and with it that feeling of “always being on” and available to take work calls or
emails. And, as research shows, employees working in such environments may actually show
lower levels of engagement – which over time could reduce their productivity. Rising real
income, the main explanation of a growing preference for shorter working hours, is much
more continuous. It is, however, arguable that basic hours have a greater role in actual hours.
Workers might be willing to replace reductions in basic hours with regular overtime, but
increasing employment could be cheaper for employers. If employers respond to reduced
basic hours by increasing employment rather than overtime, actual hours will fall irrespective
of individual preferences.
Higher hourly pay increases the cost of leisure in terms of foregone income. This leads to the
substitution of income for leisure, that is to an increase in working hours. To isolate the
substitution effect, it is necessary to imagine that income for the same hours were somehow
left unchanged by an increase in hourly pay.
For example, the increase in hourly pay might coincide with an exactly offsetting decrease in
a flat-rate income tax allowance. There would then be a substitution effect but no income
effect and working hours would rise. Working hours have fallen as real incomes have risen.
This indicates that the substitution effect is less important than the income effect. In many
cultures, long working hours and workaholism have positive connotations – such as
dedication, commitment and perseverance. But when the need for work turns so excessive
that it begins to interfere with health, personal happiness and social functioning, it can turn
into a potentially fatal disorder.
This is a particular danger of the institutionalist approach. There is disagreement over the
relationship between increased productivity and reduced hours. Looking at consequences
without considering causes can be misleading. It makes little sense to assess the
consequences of an inevitable event. If living standards determine working hours, the
consequences of changes to working hours are idle speculation. Hours could only be
different if living standards were different. .
The pressure for reduced hours was indeed an external event as far as managers at plant level
were concerned. While the reduction depended on the exercise of union power at plant level,
this power resulted from the strategy adopted by the unions nationally. Some sort of union
campaign on hours may have been inevitable given the political tensions within and between
unions. Yet, the link between the economics of the industry and union politics is far from
clear. The success of the union campaign surprised most commentators.
So, it is implausible to suppose that the economics of the industry determined the reduction
in hours.
The effects of reduced hours on the economics of the industry can be assessed without
further consideration of whether the reduction was inevitable. Another way in which causes
and consequences are connected is probably of more practical importance. If shorter hours
caused by, for instance, rising living standards had particular results, it might be wrong to
expect the same results from legislation to reduce working hours.
Certainly, overtime might well respond differently to reduced basic hours if the reduction
were a consequence of legislation rather than rising living standards.
Individual preferences are an obvious starting point when looking at the causes of shorter
working hours. Surveys suggest that people are generally satisfied with their hours of work.
When asked whether they would like to work the same, more or fewer hours between one
half and three-quarters of employees express a preference for their current hours of work.
Employers and co-workers can help colleagues who are prone to overworking by looking out
for any warning signs of workaholism. Specific times to take breaks and finish work are
vital. And everyone should be taking their holiday allowance so that they have enough time
for rest and recovery.Of course, this all sounds well and good – but job insecurity, work
pressures and an overly competitive work atmosphere can compel employees to work
extended hours – even when they know it’s damaging their health.Ultimately, most workers
today desire a life beyond work – and research shows people can be more productive if they
are able to balance their work and personal lives in more satisfying ways. Companies, for
example, that have trialled the four-day work week have found that working fewer hours
results in productivity increases due to reduced employee stress and improved focus on work
tasks.Also as working less means employees will spend less time commuting, there are
obvious payoffs for the economy (think, more time to recuperate and engage with leisure
activities) and the environment of doing away with an overwork culture.
Several studies have shown that some aspects of work are important predictors of health,
happiness, motivation and life satisfaction. For a start, the number of hours people work has
a major impact on their physical and psychological health. Evidence also suggests that long
working hours are associated with hypertension, heart disease and the risk of injuries and
accidents. Other studies have shown associations between hours of work and stress, anxiety
and depression.
The propensity to work long hours also has an adverse effect on family and social
relationships and can increase family conflict. But research studying the impact of working
hours on health has also recognized how people’s perceptions regarding long working hours
and time demands can affect this negative association.
Voluntarily opting to work longer hours as opposed to being pressured by one’s employer
can translate into big differences in health and well-being. This can help explain why some
people who work extended hours may display poorer physical and psychological well-being
compared to others.
While measures to increase productivity were a feature of collective agreements on reduced
hours, there is little evidence that productivity has been permanently increased by reduced
hours.
Overtime further complicates the union effect on working hours. Unions influence total
hours through premium rates for overtime, which are specified in British national
agreements. The declining importance of national minimum rates has resulted in increasing
scope for local negotiation. So, unions play a significant role both nationally and locally in
relation to premium rates.
The productivity-increasing measures would in general have been agreed without reduced
hours, albeit somewhat later in many cases. Price elasticity depends very much on the time
scale involved. Where there is a lot of domestic competition and little intra-industry trade,
price elasticity at plant level is very much more than at industry level. Yet, for a plant which
has no domestic competitors and relies on the domestic industry as a supplier, sales will be
affected more by an increase which applies to the entire industry.
Assuming also that a fall in sales of one per cent will result in a corresponding fall in
working hours, the cost of shorter hours, one per cent of the value of sales, reduces working
hours by no more than one per cent through lower sales.
This study, which takes account of the substitution of capital for labour, shows that higher
hourly wages reduce employment by much less than the crude estimate which considers only
the effect on sales. The effect found by the study is probably less because it considers
increased wages affecting the whole industry. The crude estimate uses information on
increases at plant level. The study supports the conclusion that the negative indirect effect of
reduced hours throughout the industry on employment and/or overtime is less than one fifth
of the positive direct effect.
There is even less evidence that reduced hours have affected output and overtime than there
is of a productivity effect. So, increased employment is left as the major consequence of
reduced hours. The recession, which was at its most serious when reduced hours were
implemented, had a much larger effect on employment. This makes the employment effect of
reduced hours hard to observe as it mainly took the form of job retention. Increased costs
may well mean that the employment effect of reduced hours is a little less than it would
otherwise have been.
Many of the potential results of shorter basic hours can be seen from the definition of labour
productivity. Labour productivity is output divided by the total hours worked. Total hours
worked are total employment multiplied by average hours, which in turn consist of basic
hours and overtime. These maximum possible effects are very much final or long-term
effects of reduced hours. The changes which take place at the time hours are reduced may
give little indication of the long-term effects. Short-term effects depend on the circumstances
surrounding reduced hours. For example, if recruitment and training costs are high, short-
term employment effects will tend to be less. Yet, if employment is being reduced for other
reasons shortly after a cut in hours, shorter working hours could affect employment quickly,
particularly where the reduction in employment takes the expensive form of redundancies.
Thus, reduced basic hours must, as a matter of arithmetic, result in some combination of
lower output, higher overtime, more employment and greater productivity. These changes
can be seen as a direct result of shorter hours. The higher labour costs caused by shorter
hours, may, however, have a possible further effect on working hours. Employers may react
to increased labour costs by using more capital relative to labour. Such substitution of capital
for labour makes the negative indirect effect on working hours larger. In addition production
costs per unit of output are nearly always increased by reduced hours. The main reason for
this is that hours are generally reduced on the basis of no change in weekly pay. The same
weekly pay for fewer basic hours means higher hourly pay. In addition unit production costs
are likely to rise because of lower capital utilisation. Increased costs will in their turn have
consequences.
For example, in most circumstances employment will be less than if costs had not increased.
The consequences of increased costs are indirect results of shorter hours. Whether
employment is increased or reduced by shorter basic hours depends on the relative size of the
direct and indirect effects. The direct effect can only increase employment, while the indirect
effect can only reduce it.
Overall output will go down. Productivity will go down. Unemployment will go down.
HOW CAN DUOPOLY BE STABLE?
Duopoly is a special case of oligopoly. Duopoly is a special case in the sense that it is
limiting case of oligopoly as there must be at least two sellers to make the market
oligopolistic in nature.

1. The Cournot’s Duopoly Model

2. The Chamberlin Duopoly Model

3. The Bertrand’s Duopoly Model

4. The Edgeworth Duopoly Model

1. Cournot’s Duopoly Model:

Augustin Cournot, a French economist, was the first to develop a formal duopoly model in
1838.

To illustrate his model, Cournot assumed:

(a) Tow firms, each owing an artesian mineral water well;

(b) Both operate their wells at zero marginal cost2;

(c) Both face a demand curve with constant negative slope;

(d) Each seller acts on the assumption that his competitor will not react to his decision to
change his and price. This is Cournot’s behavioural assumption.

On the basis of this model, Cournot has concluded that each seller ultimately supplies one-
third of the market and charges the same price. While one-third of the market remains
unsupplied.

Cournot’s duopoly model is presented in Fig. 1. To begin the analysis, suppose that there are
only two firms. A and B, and that, initially. A is the only seller of mineral water in the
market. In order to maximize his profits (or revenue), he sells quantity OQ where his MC =
O MR, at price OP2 His total profit is OP2PQ.
Now let B enters the market. The market open to him is QM which is half of the total market.
He can sell his product in the remaining half of the market. He assumes that A will not
change his price and output as he is making the maximum profit i.e., A will continue to sell
OQ at price OP2 Thus, the market available to B is QM and the demand curve is PM.
When to get maximize revenue, B sells ON at price OP1, His total revenue is maximum at
QRP’N. Note that B supplies only QN = 1/4 = (l/2)/2 of the market.) With the entry of B,
price falls to OP1 Therefore, A’s expected profit falls to OP1 PQ Faced with this situation, A
attempts to adjust his price and output to the changed conditions. He assumes that B will not
change his output QN and price OP1 as he is making maximum profit.
Accordingly, A assumes that B will continue to supply 1/4 of market and he has 3/4 (= 1 –
14) of the market available to him. To maximise his profit. Supplies 1/2 of (3/4), i.e., 3/8 of
the market. Note that A’s market share has fallen from 1/2 to 3/8.

Now it is B’s turn to react. Considering Cournot’s assumption, B assumes that A will
continue to supply only 3/8 of the market and market open to him equals 1 – 3/8 = 5/8.

In order to maximise his profit under the new conditions B supplies 1/2 x 5/8 = 5/16 of the
market. It is now for A to reappraise the situation and adjust his price and output accordingly.

This process of action and reaction continues in successive periods. In the process, A
continues to lose his market share and B continues to gain. Finally situation is reached when
their market shares equal at 1/3 each.

Any further attempt to adjust output produces the same result. The firms, therefore, reach
their equilibrium position where each one supplies one-third of the market.
(1) Curnot’s behavioural assumption [assumption (d) above] is naive to the extent that it
implies that firms continue to make wrong calculations about the competitor’s behaviour.
Each seller continues to assume that his rival will not change his output even though he
reportedly observes that his revel firm does change its output.

(2) The assumption of zero cost of production is totally unrealistic. If this assumption is
dropped, it does not alter his position

2. Chamberlin’s Duopoly Model- A Small Group Model:

Chamberlin’s model of duopoly recognizes interdependence if firms in such a market.
Chamberlin argues that in the real world of oligopoly firms are not so native that they will
not learn from the past experience. However, he makes the same assumptions as the
exponents of old classical models have done. In other words, his model is also based on the
assumption of homogeneous products, firms of equal size with identical costs, no entry by
new firms and full knowledge of demand.

Recognition of interdependence of firms in an oligopolistic market given us a result quite

different from that of Cournot. Chambrilin argues that firms are aware of the fact that their
output or price decision will definitely invite reactions of other firms. Therefore, he goes not
visualize any price war in oligopolistic markets. He also rules out the possibility of firms
adjusting their outputs over a period of time and thus reaching the equilibrium at an output
level lower than that would be reached under monopoly.

According to Chamberlin, recognition of possible sharp reactions to an oligopolistic firm’s

price or output manipulations would avert harmful competition amongst the firms in such a
market and would result in a stable industry equilibrium with the monopoly price and
monopoly output. He further stated that no collusion is required for obtained this solution.

In case farms in an oligopolistic market are aware of their mutual dependence, and willing to
learn from their past experience, then in order to maximize their individual and joint profits
they will charge the monopoly price.

Chamberlin’s model can be explained in the frame work of a dupoly market. Chamberlin,
like Cournot, assumes linear demand for the product. For simplicity we assume that even in
this case the cost of producing the good is zero.
Chamberlin’s model is certainly more realistic than earlier models. It assumes that firms
recognize interdependence and then act in a manner that monopoly solution is reached. In the
real world of oligopoly there are certain difficulties in reaching this solution. In the absence
of collusion, firms must have a good knowledge of market demand curve which is almost
impossible to obtain. In case this information is lacking, firms will not know how to reach
monopoly solution.

Further, Chamberlin ignores entry. In real practice, oligoplistic markets are rarely closed. So
if we recognize the fact of entry, it would not be certain that the stable monopoly solution
will ever be reached. Differences in costs and market opportunities are also hindrance for
attaining a monopoly-type outcome by the independent actions of firms in oligopolies.

Chamberlin model has been illustrated in Figure 2. In this figure DQ is the market demand
curve. If firm A is first to enter the market, it will produce output OQ1 because at this level of
output its marginal revenue is equal to marginal cost (MR = MC = 0). The firm can charge
price OP1 which is the monopoly price.
This will maximise its profits. At price OP) elasticity of demand is unity. Firm B entering
market at this stage considers that its demand curve is CQ and will thus produce Q1Q2 so as
to maximise its profit. It will charge price OP2.

It now realizes that it cannot sell QQ1 quantity at the monopoly price and thus decides to
reduce the output to QQ3, which is one-half of the monopoly output QQ1. Firm B can
continue to produce quantity Q1Q2 which is same as Q3Q1.
The industry output thus is OQ1 and the price rises to the level OP1. This is an ideal situation
from the point of view of both firms A and B. In this case, the joint output of the two firms is
monopoly output and they charge monopoly price. Thus, considering the assumption of equal
costs (costs = 0) the market will be shared equally between firms A and B.
3. Bertrand’s Duopoly Model:
Bertrand, a French Mathematician developed his own model of duopoly in 1883. Bertrand’s
model differs from Cournot’s model in respect of its behavioural assumption. While under
Cournot’s model, each seller assumes his rival’s output to remain constant, under Bertrand’s
model each seller determines his price on the assumption that his rival’s price, rather than his
output, remains constant.

Bertrand’s model focuses on price competition. His analytical tools are reaction function of
the duopolists. Reaction functions are derived on the basis of iso-profit curves. An iso-profit
curve, for a give level of profit, is drawn on the basis of various combinations of prices
charged by the rival firms. He assumed only two firms, A and B and their prices are
measured along the horizontal and vertical axes, respectively.

Bertrand’s model has been criticised on the same grounds as Cournot’s model. Bert- rand’s
implicit behavioural assumption that firms never learn from their past experience seems to be
unrealistic. If cost is assumed to be zero, price will fluctuate between zero and the upper limit
of the price, instead of stabilizing at a point.

Their iso-profit curves are drawn on the basis of the prices of the two firms. Iso-profit curves
of the two firms are concave to their respective prices axis, as shown in Fig. 3 and 4. Iso-
profit curves of firm A are convex to its price axis PA (Fig. 3) and those of firm B are convex
to PB (Fig. 4).

In Figure 4, we have curve A, which shows that A can earn a given profit from the various
combinations of its own and its rival’s price. For example, price combinations at points, a, b
and c yield the same level of profit indicated by the iso-profit curve A1. If firms B fixes its
prices Pb1– firm A has two alternative prices, Pa1 and Pa2, to make the same level of profits.
When B reduces its price, A may either raise its price or reduce it. A will reduce its price
when he is at point c and raise its price when he is at point a. But there is a limit to which this
price adjustment is possible. This point is shown by point b. So there is a unique price for A
to maximize its profits. This unique price lies at the lowest point of iso-profit curve.

The same analysis applies to all other iso-profit curves, A1 A2 and A3 we get A’s reaction
curve. Note that A’s reaction curve has a rightward slant. This is so because, iso-profit curve
tends to shift rightward when A gains market from his rival B.
Following the same process, B’s reaction curve may be drawn as shown in Fig. 4.

The equilibrium of duopolists suggested by Bertrand’s model may be obtained by

putting together the reaction curves of the firms A and B as shown in Fig. 5.

The reaction curves of A and B intersect at point E where their expectations materialize,
point E is therefore equilibrium point. This equilibrium is stable. Fo, if any one of the firms
disagrees to this point, it will create a series of actions and reactions between the firms which
will lead them back to point E.

4. Edgeworth’s Duopoly Model:

Edgeworth developed his model of duopoly in 1897. Edgeworth’s model follows Bertrand’s
assumption that each seller assumes his rival’s price, instead of his output, to remain
constant.

His model is illustrated in Fig. 6.

In this figure we have supposed that there are two sellers, A and B, in the market who face
identical demand curves. A has his demand curve DDB and as DDB Let us also assume that
seller A has a maximum capacity of output OM and B has a maximum output capacity of
OM’. The ordinate ODA measures the price.
To explain Edgeworth’s model, let us assume, to begin with, that A is the only seller in the
market. Following the profit maximising rule of a monopoly seller, he sells OQ and charges
a price, OP2. His monopoly profit under zero cost, equals OP2EQ Now, let B enter the
market. B assumes that A will not change his price since he is making maximum profit. He
sets his price slightly below A’s price (OP2) and is able to sell his total output. At this price,
he captures a substantial part of A’s market.
Seller A, on the other hand, that his sales have gone down. In order to regain his market, A
sets his price slightly below B’s price. This leads to price-war between the sellers.

The price- war takes the form of price-cutting which continues until price reaches OP1 At
this price both A and B are able to sell their entire output- A sells OQ and B sells OQ The
price OP1 could therefore be expected to be stable. But, according to Edgeworth, price
OP1 should not be stable.
Simple reason is that, once price OP is set in the market, the sellers observe an interesting
fact. This is, each seller realise that his rival is selling his entire output and he will therefore
not change his price, and each seller thinks that he can raise his price to OP2 and can make
pure profit.
This realisation forms the basis of their action and reaction. For examples, let seller A take
the initiative and raise his price to OP2. Assuming A to retain his price OP2.B finds that if he
raises his price at a level slightly below OP2 he can sell his entire output at a higher price and
make greater profit. Therefore, B raises his price according to his plan.
Now it is A’s turn to know the situation and react. A finds that his price is higher than B’s
price and his total sale has fallen. Therefore assuming B to retain his price, A reduces his
price slightly below B’s price.
Thus, the price-war between A and B begins once again. This process continues indefinitely
and price keeps moving up and down between OP1 and OP2 Obviously, according to
Edgeworth’s model of duopoly, equilibrium is unstable and indeterminate since price and
output are never determined. In the words form Edgeworth, “there will be an indeterminate
tract through which the index of value will oscillate, or, rather will vibrate irregularly for an
indefinite length of time.
In a net shell Edgeworth’s model, like Cournot’s is based on a native assumption, i.e. each
seller continues to assume that his rival will never change his price even though they are
proved repeatedly wrong. But according to Hotelling Edgeworth’s model is definitely an
improvement upon Cournot’s model in that it assumes price, rather than output, to be the
relevant decision variable for the sellers.