Theorie und Politik der Europäischen Integration Timo Baas Prof. Dr. Herbert Brücker Lecture 6 Market Size and Scale Effects Theory and Politics of European

Theorie und Politik der Europäischen Integration

Timo BaasProf. Dr. Herbert Brücker

Lecture 6

Market Size and Scale Effects

Theory and Politics of European Integration

Theory and Politics of European Integration Lecture 5 Preferential Trade Liberalisation

Prof. Dr. Herbert BrückerLehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer ArbeitsmärkteUniversität Bamberg | [email protected] | www.uni-bamberg.de/sowi/bruecker

Last Lecture

• Preferential Trade Liberalisation· The PTA Diagram

– Free Trade Equilibrium– MFN Tariff Equilbrium– Unilateral Trade Discrimination– Supply Switches– Welfare Effects

· Empiry: Is Trade Diversion an Issue?· Welfare Effects of a Customs Union· Customs Union vs. Free Trade Area· WTO Rules and Customs Union/Free Trade Areas

– Art. 24 WTO



Today's Lecture - Overview

• Market Size and Scale Effects



Today's Reading

• Market Size and Scale Effects· Baldwin & Wyplosz (2006) “The Economics of European

Integration”, McGraw-Hill, Ch 6.



Market Size Matters

• European leaders always viewed integration as compensating small size of European nations.• Implicit assumption: market size good for economic

performance.

• Facts: integration associated with mergers, acquisitions, etc.• In Europe and more generally, ‘globalisation.’



Facts

• M&A activity is high in EU.• much M&A is mergers within one member state

• about 55% ‘domestic’;• remaining 45% split between:

· one is non-EU firm (24%), · one firm was located in another EU nation (15%),· counterparty’s nationality was not identified (6%).



Facts

Distribution of M&A quite varied:• Big 4: share M&As much lower than share of the EU GDP.• I, F, D 36% of the M&As, 59% GDP.

· Except UK.• Small members have disproportionate share of M&A.



Facts

M&A activity by nation, 1991-2002

B, 2.8%

DK, 2.6%

EL, 1.1%

E, 5.0%F, 13.5%

IRL, 1.7%

I, 6.2%

L, 0.5%NL, 6.5%

A, 2.1%

P, 1.2%

FIN, 3.9%

S, 5.3%

UK, 31.4%

D, 16.3%



Facts

• Why M&A mostly within EU?• Why UK’s share so large?• Non harmonised takeovers rules.

· some members have very restrictive takeover practices, makes M&As very difficult.

· others, UK, very liberal rules.

• Lack of harmonisation means restructuring effects very impact by member states.



Sketch of economic logic

• liberalisation • de-fragmentation • pro-competitive effect • industrial restructuring (M&A, etc.) • RESULT: fewer, bigger, more efficient firms

facing more effective competition from each other.



Sketch of economic logic

• liberalisation • de-fragmentation • pro-competitive effect • industrial restructuring (M&A, etc.) • RESULT: fewer, bigger, more efficient firms

facing more effective competition from each other.



Economic logic (background): Monopoly case

Sales

Price

MarginalCost

Marginal RevenueCurve

DemandCurve

Sales

Price

Q’+1

P”

MarginalCost Curve

C E

D

DemandCurve

A

B

Q*Q’

P*

P’



Duopoly case, example of non-equilbrium

Residual Demand Curve firm 2 (RD2)

Firm 2’s expectation of sales by firm 1, Q1

DemandCurve (D)

MC

Residual Marginal Revenue Curve firm 2 (RMR2)

x2’

p2’

Firm 2 sales

Residual Demand Curve firm 1 (RD1)

Firm 1’s expectation of sales by firm 2, Q2

DemandCurve (D)

price

MC

Residual Marginal Revenue Curve firm 1 (RMR1)

x1’

p1’

Firm 1 sales

A1 A2

price



Duopoly and oligopoly case, equilbrium outcome

RD’

D

MC

x**

p**

sales

A

price

RMR’

3x**Oligopoly

RD

Typical firm’s expectation of the other firm’s sales

D

MC

x*

p*

sales

A

price

RMR

2x*

Duopoly

Typical firm’s expectation of other the other firms’ sales



Breakeven-Competion (BE-COMP) Diagram

Mark-up ()

COMPcurve

BE (break-even) curve

’

n’

mono

duo

n=1 n=2 Number of firms



Details of COMP curve

Marginal cost curve

Typical firm’s sales

price

p"

Monopoly mark-up

Duopoly mark-up

D

R-D (duopoly)

xmonoxduo

MR (monopoly)R-MR

MC

p'

AB

A’

B’

COMPcurve

n=1 n=2

mono

duo



Details of BE curve

Sales per firm

AC

price

Totalsales

Co

Demand curve

Mark-up (i.e., p-MC)

o

xo= Co/no

MC

euros

BE

no

poo+MC

x’= Co/n’ x”= Co/n”

A

B

B Apo

ACo=po

n” n’

Home market



No-trade-to-free-trade integration

Sales per firm

AC

price

Totalsales

Demand curve

Mark-upeuros

x’

BE

2n’

x”

n” n’

E’

E”

C’ C”

E’

A

1

E”

A

MC

p”

p’

pA

'

A

p”

p’

Home market only

E”

E’

C



Economic logic

• Integration: no-trade-to-free-trade: BE curve shifts out (to point 1).

• Defragmentation:• PRE typical firm has 100% sales at home, 0% abroad;

POST: 50-50 ,• Can’t see in diagram.

• Pro-competitive effect: • Equilibrium moves from E’ to A: Firms losing money (below BE).• Pro-competitive effect = markup falls.• short-run price impact p’ to pA.



Economic logic (cont.)

Industrial Restructuring:

• A to E”,• number of firms, 2n’ to n”. • firms enlarge market shares and output, • More efficient firms, AC falls from p’ to p”, • mark-up rises, • profitability is restored.

Result:

• bigger, fewer, more efficient firms facing more effective competition.

Welfare: gain is “C”.



Competition and subsidies

Two immediate questions:

• “As the number of firms falls, isn’t there a tendency for the remaining firms to collude in order to keep prices high?”

• “Since industrial restructuring can be politically painful, isn’t there a danger that governments will try to keep money-losing firms in business via subsidies and other policies?”

The answer to both questions is “Yes”. • See Chapter 11, 2nd Edition.



NEXT LECTURE

• November 27

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Theorie und Politik der Europäischen Integration Timo Baas Prof. Dr. Herbert Brücker Lecture 6 Market Size and Scale Effects Theory and Politics of European