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A Supergame-Theoretic Model of Business Cycles and Price Wars During Booms

  • Julio J. Rotemberg
  • Garth Saloner

This paper studies implicitly colluding oligopolists facing fluctuating demand. The credible threat of future punishments provides the discipline that facilitates collusion. However, we find that the temptation to unilaterally deflate from the collusive outcome is often greater when demand is high. To moderate this temptation,the optimizing oligopoly reduces its profitability at such times,resulting in lower prices. If the oligopolists' output is an input to other sectors, their output may increase too. This explains the co-movements of outputs which characterize business cycles. The behavior of the railroads in the 1880's, the automobile industry in the 1950's and the cyclical behavior of cement prices and price-cost margins support our theory. (J.E.L. Classification numbers:020, 130, 610).

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Paper provided by Massachusetts Institute of Technology (MIT), Department of Economics in its series Working papers with number 349.

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Date of creation: Jul 1984
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Handle: RePEc:mit:worpap:349
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  1. Sanford J. Grossman & Oliver D. Hart & Eric Maskin, 1982. "Unemployment with Observable Aggregate Shocks," NBER Working Papers 0975, National Bureau of Economic Research, Inc.
  2. Long, John B, Jr & Plosser, Charles I, 1983. "Real Business Cycles," Journal of Political Economy, University of Chicago Press, vol. 91(1), pages 39-69, February.
  3. Friedman, James W, 1971. "A Non-cooperative Equilibrium for Supergames," Review of Economic Studies, Wiley Blackwell, vol. 38(113), pages 1-12, January.
  4. Edward J Green & Robert H Porter, 1997. "Noncooperative Collusion Under Imperfect Price Information," Levine's Working Paper Archive 1147, David K. Levine.
  5. Lilien, David M, 1982. "Sectoral Shifts and Cyclical Unemployment," Journal of Political Economy, University of Chicago Press, vol. 90(4), pages 777-93, August.
  6. Robert H. Porter, 1983. "A Study of Cartel Stability: The Joint Executive Committee, 1880-1886," Bell Journal of Economics, The RAND Corporation, vol. 14(2), pages 301-314, Autumn.
  7. Porter, Robert H., 1983. "Optimal cartel trigger price strategies," Journal of Economic Theory, Elsevier, vol. 29(2), pages 313-338, April.
  8. Rotemberg, Julio J, 1982. "Sticky Prices in the United States," Journal of Political Economy, University of Chicago Press, vol. 90(6), pages 1187-1211, December.
  9. Mordecai Kurz, 1979. "A Strategic Theory of Inflation," NBER Working Papers 0379, National Bureau of Economic Research, Inc.
  10. Radner, Roy, 1980. "Collusive behavior in noncooperative epsilon-equilibria of oligopolies with long but finite lives," Journal of Economic Theory, Elsevier, vol. 22(2), pages 136-154, April.
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