Review of

RADICAL
Review of Radical Political Economics POLITICAL
Vol. 32, 1 (2000) 104-118 ECONOMICS
ELSE NIER

Technical Change and Profits:

The Prisoner’s Dilemma
Jeffrey Baldani, Thomas R. Michl *
Department of Economics, Colgate University, Hamilton, NY 13346-1398

Received 17 November 1997; accepted 26 August 1998

ABSTRACT

We examine the implications of biased-lower marginal, but higher fixed,

cost-technical change in a model of oligopoly. Such changes create an incentive
for firms to adopt new technologies in a quest for increased output, market share,
and profits. These individual incentives lead to a prisoner’s dilemma: the increase
in firms’ outputs causes market price to fall. The analysis specifies conditions
under which the decrease in price will result in lower profits for both the
individual firms and the industry as a whole.

JEL classification: L13; L23; El 1

Keywords: Oligopoly; Marx; Technology; Prisoner’s Dilemma

* Tel: (315) 228-7519; E-mail: jbaldani@mail.colgate.edu

Tel: (315) 228-7526; E-mail: tmichl@mail.colgate.edu

0486-6134/00/$-see front matter 0 2000 URPE. All rights reserved.

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This paper formalizes the claim that capitalists can be confronted by

a prisoner’s dilemma in the presence of a biased technical change:
individually rational decisions to switch to a new technology can end
up lowering profits for individual firms and for the industry as a whole.
This claim has led an existence in both the oral traditions and written
literature on Karl Marx’s controversial “law of the falling rate of
profit.” For example, in his influential text, Foley (1986: 131)
explicitly alludes to the prisoner’s dilemma situation presented by a
capital-using, labor-saving technical change, and in a much-debated
paper on the topic, Shaikh (1978) implicitly treats the problem in
similar terms by asserting that capitalist competition has a coercive
character.
The traditional approach to the Marxian theory of the falling rate of
profit assumes a general competitive equilibrium. The central idea is
that a capital-using, labor-saving technical change can cause the
system-wide rate of profit to fall after the new technique has diffused
throughout the economy. This result depends critically on the behavior
of the real wage. If the wage increases sufficiently, or equivalently if the
profit share in income does not increase sufficiently, then the rate of
profit will fall. If the real wage remains constant, the Okishio Theorem
(Okishio 1961) states that the profit rate will rise, while if the wage rises
in step with labor productivity, the profit rate will fall (Laibman 1982).
This paper focuses on the possibility that the biased nature of
technical change itself can create a prisoner’s dilemma situation, and
thus departs from the traditional approach in three ways. First, we
situate the problem in the context of imperfect competition, rather than
“perfect” competition.’ While it has long been suggested that with this
change of venue the Marxian theory becomes defensible (Van Parijs
1980: 1 l), this suggestion has not been fully explored. Some previous
attempts, such as Skott (1992) or Michl (1994), assume a monopolistic
market structure, and are unable to represent the coercive or
paradoxical aspects of biased technical change, even if they are able to
capture other aspects of the problem. This paper concentrates on the
case of Cournot oligopoly in which the strategic (in the sense that each
firm, when making its own choice of strategy must take other firms’
strategy choices into account) interaction among firms can lead to a
prisoner’s dilemma.
Second, we deploy a partial equilibrium approach. This lets us focus
on the issue of strategic interaction at the cost of ignoring the
important general equilibrium issues.

1 Indeed, Dumenil and Levy (1994) have recently suggested that some kind of
imperfect competition model-they propose monopolistic competition-better
captures what the classical economists had in mind when they referred to competition
than does the neoclassical notion of perfect competition.
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Third, we consider a biased technical change that increases fixed cost

and lowers variable costs, rather than a capital-using, labor-saving
technical change. We think there is arguably an affinity between higher
rates of mechanization and increases in fixed costs, but other interpre-
tations are possible. For example, more technically complex processes
may necessitate large start-up or transition costs that could impart a
bias toward fixed costs.
We concentrate on fixed and variable costs, and are able to ignore
the labor and capital requirements altogether. In the interests of linking
our results to the traditional literature, one could assume that firms in
the oligopolistic industry pay a given money wage. After the technical
change, we find that the industry price declines, which implies that the
real own-product wage in the industry increases. This increase will
result in a decline in industry profits under some conditions, which we
are able to characterize precisely.
The result we achieve, that individual oligopolists can be “forced”
-by competitive pressures-into adopting techniques that lower their
ex post profits, is consistent with the traditional theme that a falling rate
of profit represents an outcome contradictory to the interests of the
capitalists themselves. A monopolist would not be concerned with the
decline in the rate of profit generated by biased technical change as
long as the rate of profit remains above the opportunity cost of capital,
presumably the interest rate or the rate of profit in the competitive
sector of the economy. An oligopolist would similarly be unconcerned
about a decline in the rate of profit as long as it were associated with a
growing volume (or mass) of profit, but we show that it is possible for
biased technical change to force an oligopolist to adopt a technical
change which reduces the mass of profit too.
The key intuition for the results we derive below is that firms have an
individually rational incentive to adopt technologies that lower their
marginal costs. A single firm’s adoption of such a technology will
increase its equilibrium output, market share, and profit. Yet, when all
firms follow their individual incentives, the result is an increase in
market output and a decrease in market price. In some cases, the
decline in price will be sufficiently large so that profits fall for both the
firm and the industry. We will characterize the cases in which both the
incentive to switch and a decline in profits are an equilibrium. In
particular, we show that cost-neutral (in the sense that costs would be
the same at the original output level) technical changes will always be
adopted and will always lower profits.
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1. The Model

The model uses a Cournot-Nash oligopoly model with a linear demand

function. We write the demand equation as

P=a-Q (1)
where Q, total market output, is the sum of the individual outputs, qi,
n
of the n firms, Q = cqi . The number of firms, n, is assumed fixed
i=l
throughout the analysis. On the entry side, this may be due to barriers
that block new firms from the market. On the exit side, we assume that
profits remain positive, even when adoption of a new technology causes
profits to fall, so that the issue of firm exit does not arise.
Each firm has a choice of two technologies. Both technologies have
a constant marginal cost, c, plus a fixed cost, f . The initial technology
has a cost function of

TC, =cq+f. (2)

The new technology has a total cost of

TC,,, =cNq+ fN. (3)

We model a technological change that reduces marginal costs, but

increases fixed costs.’ We simplify the model’s notation by assuming

C N=C-xX,X>O
and (4)
fN=f+YYY>O
In the final equilibria described below all firms will choose the new
technology. However, in order to derive the equilibria we must first
examine the incentives for individual firms to switch to a new
technology and cost structure. To examine these incentives we model
the case where some firms have switched to the new technology, but
others have continued using the old technology. Let m, 0 I m 5 IZ, be
the number of firms that have adopted the new technology and n-m
be the number of firms operating with the old technology. Profits for
individual firms of each type are given by

2 For some evidence, from an economic historian, that technical change

systematically takes such a form see Lazonick (1990).
108 J. Baldani, T.R. Michl / Review of Radical Political Economics 32, 1 (2000)
104-118

Q,i = (a - Qkoj - cq,, - f

and (5)
nhrj =(a--Q)qw --(c-x)qw -f--y.

The first order conditions for profit maximization for the two types of
firms are

anOi _
--u-Q-qOi-c=O
&h
and (6)

In equilibrium all firms of a given technology type will produce the

same output. Let q0 and qN represent these equilibrium output levels.
The equilibrium market output will then be Q = (n - m)q, + mq,. This
allows us to solve the first order conditions as

a-c-mx
4; =
n+l
and (7)
a-c+(n--+1)x
4; =
n+l
The analysis below proceeds under the assumption that x (the degree
of technical change measured in terms of marginal costs) is sufficiently
small so that both technologies could viably coexist, i.e., firms with the
old technology would continue to produce at positive output levels.3
This requires the solution for 4; to be positive. When both
technologies are being used, and all but one firm have switched to the
new technology, then m = n - 1. The old technology remains viable as

3 Although we use this assumption extensively in deriving the results below, the
assumption is not necessary. The basic conclusions continue to hold for “large”
technological changes. The mathematical analysis, however, becomes considerably
messier since it becomes necessary to impose a non-negativity constraint on
quantities in the profit maximization and equilibrium equations.
 .I. Baldani, T. R. Michl / Review of Radical Political Economics 32, 1 (2000) 109
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long as the single firm still using it has a positive output.4 Rearranging
equation (7) we find that 4; is positive when the following condition is
met.

Condition 1: Viability

The two technologies are simultaneously viable when

a-c
a-c-(n-l)x>O or n<x,,=-.
n-l
The viability condition requires that the drop in marginal cost be small
enough so that firms using the old technology will still operate in
equilibrium. This condition will be helpful for signing terms and
deriving results later in the paper.
Given the outputs of the two types of firms, market output and price
will be

n(a-c)+mx
Q*=(n-m&,+m&=
n+l
and (8)
P* Q-Q’ = a+nc-n2.x
n+l *
Substituting these solutions into the profit functions gives the profits
for the respective firm types as

(a-c-mx)2
no= (n+l)*
-f
and (9)
n = (a--++n-m+1)x)2 -f-y

N
(n+1)2

We now examine when an individual firm will choose to adopt the

new technology. What we are ultimately interested in is the case where
all firms adopt the new technology, but to derive the condition for
universal adoption we must first examine the incentives for an

4 Long-run viability would also require that both types of firms earn non-negative
profits. This, however, does not matter in the analysis below, since we focus on the
case where all firms switch to the new technology.
1 10 J. Baldani, T.R. Michl / Review of Radical Political Economics 32, I (2000)
104-118

individual firm when some, but not necessarily all, other firms have
already switched.
While our discussion below is sometimes couched in dynamic
language, each of the two stages (technology adoption and output
choice) is static. A firm’s first-stage technology choice is made by
looking ahead to the output stage, and comparing the static output
equilibrium in which it has stayed with the old technology with the
static output equilibrium where it has switched to the new technology.5
Since adoption is a dominant strategy in the cases modelled below,
there is no real dynamic linkage between the two stages.
To model the adoption choice for some firm k, suppose that firms 1
to k- 1 have adopted the new technology and that firms k+l to IE have
stayed with the old technology. Firm k can thus choose to stick with
the original technology and earn a profit level given by L’, in
equation (9) with k-l substituted for m; or firm k can switch to the
new technology and earn a profit level given by III, with m = k . Firm
k will adopt the new technology if

n&,2 “*
(m=k) (nr=k-I)
(a-c;;+;;2+l)x)’ -f-y2 (o-;~~l-$x)2 -f
(10)
or

Notice that the requirement that both technologies be viable (condition

1) ensures that the last term in parentheses on the left side must be
positive. Thus, all technological changes with sufficiently small
increases in fixed costs, y, will be adopted. Intuitively, individual firms
have an incentive to reduce marginal costs because lower marginal cost
leads to a higher equilibrium output and higher market share that offset
the increase in fixed costs.
Because the left side of equation (10) is decreasing in k, there may
be technological changes that are adopted by only some of the firms in

5 Because adoption is a dominant strategy, our results would be the same even if
firms made adoption decisions sequentially. The static versus sequential adoption
distinction would matter, however, if (1) firms were also making capacity choices or
other irreversible decisions that would affect the output game equilibrium or (2) firms
were playing a sequential Stackelberg output game, as in Anderson and Engers (1992),
so that the adoption sequence had output and profit consequences.
 J. Baldani, T.R. Michl / Review of Radical Political Economics 32, I (2000) 1 11
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the industry.6 In what follows, however, we focus on new technologies

that are adopted by all firms so that equation (10) holds for k = n.
Rewriting equation (lo), with k = n, gives the conditions under which a
new technology will be adopted by all firms. This is condition 2.

Condition 2: Adoption

All firms will switch to a new technology if

The left side of condition 2 is a measure of the last adopter’s profit

gain (relative to retaining the old technology when all other firms have
switched) from the reduction in variable production costs. The
condition requires that this gain be larger than the increase in fixed
cost.’
Although universal adoption of a new technology may raise profits,
under some conditions adoption actually lowers industry (and
individual firms’) profits. From equation (9) we have profits before
adoption (m = 0) and after adoption (m = n) as

l-J =(a-c)'_f
o (n+1)2
and (11)
n Ja-c+X)2-f-y
N
(n+1)2 a

Profits fall when

4l’~N
or (12)
(n+1)2y>x(2(a-c)+x).

6 The case where some firms adopt a new technology and others do not will be the
topic of a separate paper.
7 Note that the when x = 0 there is no gain, and that as x increases the gain
increases. Since the left side of condition 2 is a quadratic equation (parabola), it will
eventually be declining in x, but the region where it declines is not relevant: it
violates condition 1 and the non-negativity constraints on quantities. Figure 1 below
shows only the relevant section of the equation in condition 2.
1 12 J. Baldani, T.R. Michl / Review of Radical Political Economics 32, 1 (2000)
104-118

We rewrite this as condition 3.

Condition 3: Profit Decreases

A new technology will cause profits to fall if

7-32(a-4x+x2].
Here, the right side gives the profit benefit (when all firms adopt)
that results from the lower variable costs of the new technology.
Condition 3 states that overall profits will fall if the increase in fixed
costs outweighs the gain from lower variable costs.
The new technology reduces marginal cost, but the trade-off is a
higher fixed cost. Condition 2 tells us that firms will adopt the new
technology if the increase in fixed costs, y, is sufficiently small.
Condition 3 states that the new technology will be unprofitable if the
increase in fixed costs, y, is sufficiently large. There is an intermediate
range of y values such that all firms adopt and profits fall. To illustrate
this suppose that the lower profit condition in equation (12) holds so
that we can write the equation as

(n+1)2y=x(2(a-c)+x)+&, &>O. (13)

Substituting into condition 2 we find that the profit-lowering change

will be adopted if

nx(2(a-c)-(n-2)x)>x(2(a-c)+x)+&
(2n-2)(a-c)-(n2-2n+l)x2& (14)
2(u-C)-(n-1)x2&.

Condition 1 ensures that the last inequality will hold for sufficiently
small values of E. Therefore, there exists a range of E such that
unprofitable technologies are adopted by all firms. Note, in particular,
that marginally unprofitable technologies, E approaching zero, are
always adopted.
Figure 1 gives a more general overview. The top curve in figure 1 is
a graph of condition 2. Points below the curve represent new
technologies, with sufficiently low fixed cost increases, that would be
adopted by all firms. The lower curve is a graph of condition 3. Points
above this curve represent new technologies, with sufficiently large
fixed cost increases, that result in lower profits. Both curves are graphed
over the range of technological changes in which both technologies are
 J. Baldani, T.R. Michl / Review of Radical Political Economics 32, 1 (2000) 113
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simultaneously viable, i.e., the functions are truncated at nmax,the point

specified by condition 1, at which the technologies are no longer
simultaneously viable. The shaded region shows the new technologies
that would be adopted despite the fact that they lead to lower profits.
Although we can not draw any sweeping conclusions, figure 1
suggests that profit reducing changes are not just special cases. In
particular, changes that are “small,” in the sense that they are close to
the adoption curve, will always be profit-reducing.

Y
New
Tech
Not
Adopted

Profit Condition

X
Xmax

Fig. 1. Adoption and Profit Regions

2. Cost Neutral Technical Change

Due to the nature of the technical change, higher fixed but lower
marginal costs, there is no general way of directly comparing two
technologies. For any two technologies there will be some output level
1 14 J. Baldani, T.R. Michl / Review of Radical Political Economics 32, I (2000)
104-l 18

at which the total and average costs for the two technologies are
identical. One case where a heuristic comparison is possible is a
technological change that is cost neutral, in the sense that average cost
is unchanged, at the original output.
On the surface, the two technologies seem the same. Hypothetically,
if outputs were unchanged, then the new technology would yield the
same profit as the old. Yet, the essence of the prisoner’s dilemma is that
the hypothetical fails. The new technology offers the same costs at the
original output, but lower costs at higher output levels. This is an
attractive lure to individual firms, but collectively it is illusory: we will
show that the increase in output necessarily leads to a profit-reducing
decline in price in this case.

- AC
N
c-x

9
qO

Fig. 2. Cost Neutral Technical Change

The cost curves for a neutral change are shown in figure 2. To solve
for the cost-neutral values of the change parameters x and y, we
evaluate total costs for the two technologies at &, and set the costs
equal. This gives
 J. Baldani, T.R. Michl /Review of Radical Political Economics 32, I (2000) 115
104-118

(c-x)%+f+y=Cs+f
or (15)
X(U - c)
y= (n+l) .

We first examine whether this cost neutral change will be adopted by

all firms. By condition 2 the change is adopted if

1 (a - c)x
-[2n(a-c)x-n(n-2)x2]2y=-
(n+l)* (n+l)
or (16)
(n-l)(a-c-x)+x20.

This inequality holds (strictly) under viability condition 1. Next, from

condition 3 neutral changes will be profit-reducing if

(a - c)x 1
-->-[2(u-c)x+x2)]
y= (n+l) (n+l)*
or (17)
(n-l)(a-C)-XX>.

Once again, condition 1 is sufficient for the strict inequality. In terms

of figure 1, cost-neutral technological changes fall strictly within the
shaded area where changes are both adopted and profit-reducing.
What is happening here is that as the new technology is adopted,
firms respond to the new, lower, marginal cost by expanding output,
and (at the new output) achieve a lower average production cost.
Nonetheless, the reductions in average cost and the increase in output
are more than offset by the drop in market price so that the net effect is
a drop in profits. Thus, the firms are caught in a prisoner’s dilemma:
individually rational switches to the new technology turn out to be
always profit-reducing when technical change is cost-neutral.

3. A Numerical Duopoly Example

We conclude our analysis with a numerical duopoly example of the

prisoner’s dilemma. Let the parameter values be
a =12
C z 6
f =l
X = 3 (CN =3)
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104-118

y =7 <f, =8)
Initially both firms produce 2 units of output and, at a market price of
$8/unit, earn a profit of $3.* If one firm adopts the new technology
then its output rises to 4 units, while the firm with the original
technology suffers an output decline to 1 unit. The market price drops
to $7/unit and the firms earn profits of $8 and $0, respectively. Thus,
the new technology generates a competitive advantage for the adopter.
Yet, when both firms switch to the new technology, each produces an
output of 3, the market price falls to $6/units, and profits fall to $1.
The payoff matrix for the prisoner’s dilemma is:

Firm 2
Old New
Old
Firm 1
New

Clearly, adoption of the new technology is a dominant, but profit

reducing, strategy.

4. Conclusion

The model illustrates the dilemma of firms in an oligopolistic

market. New technologies with lower marginal, but higher fixed, costs
are attractive to individual firms. From the firm’s point of view the
lower marginal cost offers a chance for increased production, market
share, and profits, Nevertheless, when all firms pursue their self interest,
the market share advantage proves illusory; the market price
necessarily falls; and the decline in price may outweigh the increase in
production so that profits fall as well.
Price decreases would be reflected in an increase in the own-product
wage (assuming a constant money wage). Thus, as in most modern
literature on the topic, the possibility of declining profits depends on
the extent to which the real own-product wage rises after a technical
change.
This result lends some support to one interpretation of Marx’s law of
the tendency for the profit rate to fall, namely, that it rests on the
prisoner’s dilemma created by technical changes. In order to arrive at

* Note that this is not a cost-neutral change: at the original output of 2 units, the
new technology has higher total and average costs. The parameter values in the
example were chosen to give simple numerical solutions, but examples of other cases
can be constructed fairly easily.
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this result, however, we have departed from the usual treatment of the
falling rate of profit in a number of ways, including a microeconomic
setting and the assumption that technical change is biased toward
saving marginal costs while increasing fixed costs.
Although our model is essentially static, many of the interesting
questions concerning technological change and profits are dynamic.
We conclude with some discussion of how dynamic issues might be
incorporated into future research. In particular, we offer some
speculations as to whether biased profit-reducing technological changes
might be common phenomena.
The generation of new technologies is an ongoing process and the
dynamics of changing technological opportunities might be modeled
as either an exogenous or endogenous process. Our model has treated
change as exogenous and dichotomous, one old technology versus one
new technology.
One alternative might be to treat technologies as exogenous but
evolving. As an example, suppose that an alternative technology is
initially unattractive to firms because the fixed cost increase, y, is large
and the marginal cost decrease, x, is small. As knowledge and general
technical prowess advance over time, y will fall and x will increase so
that new technologies become more attractive. The time of adoption
then becomes a choice variable for the firms. Without a formal
dynamic model there is no clear answer as to when technical changes
will be adopted. It is at least possible, however, that oligopolists, seeking
a competitive advantage, will succumb to the prisoner’s dilemma by
adopting changes as soon as the profit consequences make the switch
individually rational. This scenario would (as presented in figure 1) be
a case in which universal adoption leads to lower profits.
A second alternative is to model technical change as an endogenous
process that is driven by firms’ research and development choices. A
straightforward extension in this direction, which is consistent with the
static model, is to view research and development costs as fixed costs
that firms incur in order to achieve lower production costs. The results
we have derived above suggest that the prisoner’s dilemma might drive
firms to engage in profit-reducing research and development spending.
A more complicated endogenous model might consider how
research and development spending could be targeted at changing a
firm’s cost structure in particular directions. Consider alternative
technologies that, in contrast to our model, have lower fixed and higher
marginal costs (and would hence raise industry profits). The analysis
above suggests that individual firms would not have an incentive to
develop such technologies since the increase in marginal costs would
put any adopter at. a competitive disadvantage.
Thus, research and development activities may tend to be biased
towards creating methods of production that trade off higher fixed
costs for lower marginal costs. If research and development spending is
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104-118

biased in this way, and if, as is arguably the case, higher degrees of
mechanization are linked to higher fixed and lower marginal costs,
then firms’ research and development efforts might lead to both
increased mechanization and a prisoner’s dilemma of falling profits.

Acknowledgment

We would like to thank Eric Nilsson, Bruce Pietrykowski, and

Anuradha Seth for their helpful comments and suggestions. The usual
disclaimer applies.

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