Baldwin

1
The Economics of European Integration
2
Chapter 6Market Size and Scale Effects
3
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.

4
Facts

• MA activity is high in EU.
• much MA 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),
• counterpartys nationality was not identified
  (6).

5
Facts

• Distribution of MA quite varied
• Big 4 share MAs much lower than share of the EU
  GDP.
• I, F, D 36 of the MAs, 59 GDP.
• Except UK.
• Small members have disproportionate share of MA.

6
Facts

• Why MA mostly within EU?
• Why UKs share so large?
• Non harmonised takeovers rules.
• some members have very restrictive takeover
  practices, makes MAs very difficult.
• others, UK, very liberal rules.
• Lack of harmonisation means restructuring effects
  very impact by member states.

7
Theory Economic Logic Verbally

• liberalisation ?
• de-fragmentation ?
• pro-competitive effect ?
• industrial restructuring (MA, etc.)
• RESULT fewer, bigger, more efficient firms
  facing more effective competition from each
  other.

8
Economic logic background
Monopoly case
Demand Curve
Marginal Revenue Curve
Price
Price
Demand Curve
Marginal Cost Curve
P
P
A
P
B
D
Marginal Cost
C
E
Q
Q
Sales
Q1
Sales
9
Duopoly case, example of non-equilibrium
price
price
Firm 2s expectation of sales by firm 1, Q1
Firm 1s expectation of sales by firm 2, Q2
Demand Curve (D)
Demand Curve (D)
p1
p2
Residual Demand Curve firm 1 (RD1)
Residual Demand Curve firm 2 (RD2)
MC
MC
A1
A2
x2
x1
Firm 2 sales
Firm 1 sales
Residual Marginal Revenue Curve firm 2 (RMR2)
Residual Marginal Revenue Curve firm 1 (RMR1)
10
Duopoly oligopoly case, equilibrium outcome
price
price
Typical firms expectation of the other firms
sales
Typical firms expectation of other the other
firms sales
p
D
D
p
RD
RD
MC
A
MC
A
RMR
RMR
sales
sales
x
x
2x
3x
Oligopoly
Duopoly
11
BE-COMP diagram
12
Details of COMP curve
Mark-up
price
mmono
p'
A
p"
mduo
B
D
Monopoly mark-up
Duopoly mark-up
COMP curve
R-D (duopoly)
Marginal cost curve
MC
A
B
Number of firms
n1
n2
R-MR
MR (monopoly)
Typical firms sales
xmono
xduo
13
Details of BE curve
Mark-up (i.e., p-MC)
euros
price
Home market
pomoMC
BE
Demand curve
A
ACgtpo
ACopo
B
A
po
mo
B
ACltpo
AC
MC
no
n
n
Number of firms
Sales per firm
Total sales
Co
x Co/n
x Co/n
xo Co/no
14
Equilibrium in BE-COMP diagram
Price
Mark-up
euros
Home market
Demand curve
BE
E
E
E
m'
p
p
AC
COMP
MC
Number of firms
n
Sales per firm
Total sales
x
C
15
No-trade-to-free-trade integration
price
Mark-up
euros
Home market only
Demand curve
BE
BEFT
E
1
E
E
m'
p
p
E
C
E
E
p
p
A
A
pA
mA
AC
COMP
MC
Number of firms
2n
n
n
Sales per firm
x
Total sales
C
C
x
16
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 ,
• Cant 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.

17
Competition Subsidies

• 2 immediate questions
• As the number of firms falls, isnt there a
  tendency for the remaining firms to collude in
  order to keep prices high?
• Since industrial restructuring can be
  politically painful, isnt 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.