Transcript Chapter 6

The Economics of
European Integration
© Baldwin & Wyplosz 2006
Chapter 6
Market Size
and Scale
Effects
© Baldwin & Wyplosz 2006
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.’
© Baldwin & Wyplosz 2006
Facts
• M&A activity is high in EU.
• much M&A is mergers within 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%).
© Baldwin & Wyplosz 2006
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.
M&A activity by nation, 1991-2002
B, 2.8%
UK, 31.4%
DK, 2.6%
EL, 1.1%
S, 5.3%
IRL, 1.7%
NL, 6.5%
L, 0.5%
I, 6.2%
A, 2.1%
P, 1.2%
F, 13.5%
D, 16.3%
E, 5.0%
FIN, 3.9%
– Small members have
disproportionate share of
M&A.
© Baldwin & Wyplosz 2006
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.
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Theory: Economic Logic
Verbally
•
•
•
•
•
liberalisation 
de-fragmentation 
pro-competitive effect 
industrial restructuring (M&A, etc.)
RESULT: fewer, bigger, more efficient
firms facing more effective competition
from each other.
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Economic logic: background
Monopoly case
Demand
Curve
Price
P’
P”
C
Marginal Revenue
Curve
Marginal
P*
Cost Curve
A
B
Price
Demand
Curve
D
Marginal
Cost
E
Q’ Q’+1
Sales
Q*
Sales
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Duopoly case, example of non-equilibrium
price
price
Firm 1’s expectation of
sales by firm 2, Q2
p1’
Firm 2’s expectation of
sales by firm 1, Q1
Demand
Curve (D)
p2’
Residual Demand
Curve firm 1 (RD1)
A1
MC
x1’
Firm 1 sales
Residual Marginal Revenue
Curve firm 1 (RMR1)
Demand
Curve (D)
Residual Demand
Curve firm 2 (RD2)
MC
A2
x2 ’
Firm 2 sales
Residual Marginal Revenue
Curve firm 2 (RMR2)
© Baldwin & Wyplosz 2006
Duopoly & oligopoly case, equilibrium outcome
price
Typical firm’s expectation
of the other firm’s sales
p*
Typical firm’s expectation
of other the other firms’
sales
price
D
D
p**
RD
RD’
A
MC
A
RMR
x*
Duopoly
MC
RMR’
2x* sales
x**
sales
3x**
Oligopoly
© Baldwin & Wyplosz 2006
BE-COMP diagram
Mark-up (m)
mmono
mduo
BE (break-even) curve
m’
COMP
curve
n=1 n=2
n’
Number
of firms
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Details of COMP curve
Mark-up
price
p'
mmono
A’
p"
mduo
B’
D
Monopoly
mark-up
Duopoly
mark-up
MC
COMP
curve
R-D (duopoly)
B
Marginal cost
curve
A
R-MR
xduo
n=1
n=2
Number of
firms
MR (monopoly)
xmono
Typical firm’s sales
© Baldwin & Wyplosz 2006
Details of BE curve
euros
price
Mark-up
(i.e., p-MC)
Home market
po=mo+MC
BE
Demand curve
AC>po
A
ACo=po
mo
po
AC<po
B
A
B
AC
MC
Sales
per firm
x’= Co/n’
x”= Co/n”
n” no
Co
n’
Number
of firms
Total
sales
xo= Co/no
© Baldwin & Wyplosz 2006
Equilibrium in BE-COMP
diagram
euros
Price
Mark-up
Home market
Demand curve
E’
p’
p’
BE
E’
m'
E’
AC
COMP
MC
x’
Sales
per firm
n’
C’
Number
of firms
Total
sales
© Baldwin & Wyplosz 2006
No-trade-to-free-trade
integration
euros
price
Mark-up
Home market only
Demand curve
BE
BE
p’
p”
E’
E’
p’
E”
p”
C
m'
E’
A
1
E”
E”
pA
mA
A
AC
COMP
MC
x’ x”
Sales
per firm
FT
n’
C’ C”
n”
2n’
Number
of firms
Total
sales
© Baldwin & Wyplosz 2006
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.
• 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”.
© Baldwin & Wyplosz 2006
Competition & Subsidies
•
2 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 moneylosing firms in business via subsidies and other policies?”
•
•
The answer to both questions is “Yes”.
See Chapter 11, 2nd Edition.
© Baldwin & Wyplosz 2006