Transcript Baldwin & Wyplosz The Economics of Euroepan Integration
Chapter 6: Market Size and Scale Effects
© Baldwin & Wyplosz 2006. The Economics of European Integration, 2 nd Edition 1
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. The Economics of European Integration, 2 nd Edition 2
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. The Economics of European Integration, 2 nd Edition 3
• 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.
Facts
M&A activity by nation, 1991-2002
UK, 31.4% S, 5.3% NL, 6.5% I, 6.2% F, 13.5% E, 5.0% D, 16.3% B, 2.8% DK, 2.6% EL, 1.1% IRL, 1.7% L, 0.5% A, 2.1% P, 1.2% FIN, 3.9% © Baldwin & Wyplosz 2006. The Economics of European Integration, 2 nd Edition 4
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.
© Baldwin & Wyplosz 2006. The Economics of European Integration, 2 nd Edition 5
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. © Baldwin & Wyplosz 2006. The Economics of European Integration, 2 nd Edition 6
Economic logic: background
Monopoly case
Price
Demand Curve
Price
Marginal Revenue Curve
P’ P”
A
Marginal Cost Curve
P*
Demand Curve
B C D
Marginal Cost
Q’
E
Q’+1
Sales
Q*
Sales
© Baldwin & Wyplosz 2006. The Economics of European Integration, 2 nd Edition 7
Economic logic: background
Duopoly case, example of non-equilibrium
price price Firm 1’s expectation of sales by firm 2, Q 2 Firm 2’s expectation of sales by firm 1, Q 1
p 1 ’ Demand Curve (D) Residual Demand Curve firm 1 (RD1) p 2 ’ Demand Curve (D)
A 1
MC
A 2
Residual Demand Curve firm 2 (RD2) MC x 1 ’ Residual Marginal Revenue Curve firm 1 (RMR1)
Firm 1 sales
x 2 ’
Firm 2 sales
Residual Marginal Revenue Curve firm 2 (RMR2) © Baldwin & Wyplosz 2006. The Economics of European Integration, 2 nd Edition 8
Economic logic: background
Duopoly & oligopoly case, equilibrium outcome
price Typical firm’s expectation of the other firm’s sales price Typical firm’s expectation of other the other firms’ sales
p* D D p** RD RD’
A
x* Duopoly RMR MC 2x*
sales A
MC RMR’ x** 3x**
sales
Oligopoly © Baldwin & Wyplosz 2006. The Economics of European Integration, 2 nd Edition 9
Mark-up (
m
)
m mono
BE-COMP diagram
m duo m ’ BE (break-even) curve COMP curve n=1 n=2 n’
Number of firms
© Baldwin & Wyplosz 2006. The Economics of European Integration, 2 nd Edition 10
Details of COMP curve
Mark-up price
p' m mono
A’
p" m duo
B’
MC Duopoly mark-up D Monopoly mark-up R-D (duopoly)
B A
Marginal cost curve R-MR MR (monopoly) x duo x mono n=1 n=2 COMP curve
Number of firms Typical firm’s sales
© Baldwin & Wyplosz 2006. The Economics of European Integration, 2 nd Edition 11
Details of BE curve
euros
p o =m o +MC
price
Home market Demand curve AC>p o
A
AC o =p o p o
B
AC
Sales per firm
C o
Mark-up (i.e., p-MC)
m o
Total sales B
n” n o n’ BE
A Number of firms
© Baldwin & Wyplosz 2006. The Economics of European Integration, 2 nd Edition 12
p’
euros
Equilibrium in BE-COMP diagram
Mark-up Price
Home market Demand curve BE
E’
p’
E’
m '
E’
x’ AC MC
Sales per firm
n’ COMP
Number of firms
C’
Total sales
© Baldwin & Wyplosz 2006. The Economics of European Integration, 2 nd Edition 13
No-trade-to-free-trade integration
p’ p”
euros E’ E”
AC MC p’ p” p A x’ x”
Sales per firm price
Home market only Demand curve
C
E’ E” A Mark-up
m m ' A
E’ E”
1 BE BE FT
A
COMP n’ n” 2n’
Number of firms
C’ C”
Total sales
© Baldwin & Wyplosz 2006. The Economics of European Integration, 2 nd Edition 14
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 .
• 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. The Economics of European Integration, 2 nd Edition 15
• • •
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, 2 nd Edition.
© Baldwin & Wyplosz 2006. The Economics of European Integration, 2 nd Edition 16