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

Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | | Theory and Politics of European IntegrationLecture 5 Preferential Trade Liberalisation 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

Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | | Theory and Politics of European IntegrationLecture 5 Preferential Trade Liberalisation Today's Lecture - Overview Market Size and Scale Effects

Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | | Theory and Politics of European IntegrationLecture 5 Preferential Trade Liberalisation Today's Reading Market Size and Scale Effects ·Baldwin & Wyplosz (2006) “The Economics of European Integration”, McGraw-Hill, Ch 6.

Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | | Theory and Politics of European IntegrationLecture 5 Preferential Trade Liberalisation 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.’

Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | | Theory and Politics of European IntegrationLecture 5 Preferential Trade Liberalisation 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%).

Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | | Theory and Politics of European IntegrationLecture 5 Preferential Trade Liberalisation 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.

Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | | Theory and Politics of European IntegrationLecture 5 Preferential Trade Liberalisation Facts

Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | | Theory and Politics of European IntegrationLecture 5 Preferential Trade Liberalisation 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.

Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | | Theory and Politics of European IntegrationLecture 5 Preferential Trade Liberalisation 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.

Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | | Theory and Politics of European IntegrationLecture 5 Preferential Trade Liberalisation 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.

Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | | Theory and Politics of European IntegrationLecture 5 Preferential Trade Liberalisation Economic logic (background): Monopoly case Sales Price Marginal Cost Marginal Revenue Curve Demand Curve Sales Price Q’+1 P” Marginal Cost Curve CE D Demand Curve A B Q* Q’ P* P’

Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | | Theory and Politics of European IntegrationLecture 5 Preferential Trade Liberalisation Duopoly case, example of non-equilbrium Residual Demand Curve firm 2 (RD2) Firm 2’s expectation of sales by firm 1, Q 1 Demand Curve (D) MC Residual Marginal Revenue Curve firm 2 (RMR2) x2’x2’ p2’p2’ Firm 2 sales Residual Demand Curve firm 1 (RD1) Firm 1’s expectation of sales by firm 2, Q 2 Demand Curve (D) price MC Residual Marginal Revenue Curve firm 1 (RMR1) x1’x1’ p1’p1’ Firm 1 sales A1A1 A2A2 price

Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | | Theory and Politics of European IntegrationLecture 5 Preferential Trade Liberalisation 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

Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | | Theory and Politics of European IntegrationLecture 5 Preferential Trade Liberalisation Breakeven-Competion (BE-COMP) Diagram Mark-up (  ) COMP curve BE (break-even) curve ’’ n’  mono  duo n=1 n=2 Numb er of firms

Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | | Theory and Politics of European IntegrationLecture 5 Preferential Trade Liberalisation Details of COMP curve Marginal cost curve Typical firm’s sales price p" Monopoly mark-up Duopoly mark-up D R-D (duopoly) x mono x duo MR (monopoly) R-MR MC p' A B A’ B’ COMP curve n=1 n=2  mono  duo

Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | | Theory and Politics of European IntegrationLecture 5 Preferential Trade Liberalisation Details of BE curve Sales per firm AC price Total sales CoCo Demand curve Mark-up (i.e., p-MC) oo x o = C o /n o MC euros BE nono p o  o +MC x’= C o /n’ x”= C o /n” A B BA popo AC o =p o n”n’ Home market

Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | | Theory and Politics of European IntegrationLecture 5 Preferential Trade Liberalisation No-trade-to-free-trade integration Sales per firm AC price Total sales Demand curve Mark-upeuros x’ BE 2n’ x” n”n’ E’ E” C’C” E’ A 1 E” A MC p” p’ pApA '' AA p” p’ Home market only E” E’ C

Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | | Theory and Politics of European IntegrationLecture 5 Preferential Trade Liberalisation 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 p A.

Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | | Theory and Politics of European IntegrationLecture 5 Preferential Trade Liberalisation 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”.

Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | | Theory and Politics of European IntegrationLecture 5 Preferential Trade Liberalisation 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, 2 nd Edition.

Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | | Theory and Politics of European IntegrationLecture 5 Preferential Trade Liberalisation NEXT LECTURE November 27