The Economics of European Integration
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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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Chapter 6Market Size and Scale Effects


Market size matters
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
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%).


Facts1
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.


Facts2
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.


Theory economic logic verbally
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.


Economic logic background
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


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)


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


Be comp diagram

Mark-up (m)

mmono

mduo

BE (break-even) curve

m’

COMP

curve

n=2

n=1

n’

Number of firms

BE-COMP diagram


Details of comp curve
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


Details of be curve
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


Equilibrium in be comp diagram
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’


No trade to free trade integration
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’


Economic logic
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”.


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 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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