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The Economics of European Integration

The Economics of European Integration. Chapter 6 Market Size and Scale Effects. Market Size Matters. European leaders always viewed integration as compensating small size of European nations. Implicit assumption: market size good for economic performance.

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The Economics of European Integration

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  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 • 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%).

  5. 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.

  6. 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.

  7. 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.

  8. Economic logic: background Monopoly case Demand Curve Marginal Revenue Curve Price Price Marginal Cost Curve Demand Curve P* P’ A P” B D Marginal Cost C E Q* Q’ Sales Q’+1 Sales

  9. Duopoly case, example of non-equilibrium price price Firm 1’s expectation of sales by firm 2, Q2 Firm 2’s expectation of sales by firm 1, Q1 Demand Curve (D) Demand Curve (D) p1’ p2’ Residual Demand Curve firm 1 (RD1) Residual Demand Curve firm 2 (RD2) MC MC A1 A2 x1’ x2’ Firm 1 sales Firm 2 sales Residual Marginal Revenue Curve firm 1 (RMR1) Residual Marginal Revenue Curve firm 2 (RMR2)

  10. Duopoly & oligopoly case, equilibrium outcome price price Typical firm’s expectation of the other firm’s sales Typical firm’s expectation of other the other firms’ sales p* D D p** RD RD’ A A MC MC RMR RMR’ sales sales x* 2x* x** 3x** Duopoly Oligopoly

  11. Mark-up (m) mmono mduo BE (break-even) curve m’ COMP curve n=2 n=1 n’ Number of firms 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 B A Number of firms n=1 n=2 R-MR MR (monopoly) Typical firm’s sales xduo xmono

  13. Details of BE curve Mark-up (i.e., p-MC) euros price Home market po=mo+MC BE Demand curve A AC>po ACo=po B A po mo B AC<po AC MC n” no 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 euros Price Mark-up Home market Demand curve BE E’ E’ m' E’ p’ p’ AC COMP MC Number of firms n’ Sales per firm Total sales C’ x’

  15. No-trade-to-free-trade integration euros price Mark-up Home market only Demand curve BE BEFT E’ 1 E’ E’ m' p’ p’ E” C E” E” p” p” A A mA pA AC COMP MC Number of firms n’ n” 2n’ 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 , • 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”.

  17. 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 money-losing firms in business via subsidies and other policies?” The answer to both questions is “Yes”. See Chapter 11, 2nd Edition. Competition & Subsidies

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