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Theorie und Politik der Europäischen Integration

Theorie und Politik der Europäischen Integration . Theory and Politics of European Integration . Lecture 4 Market Size and Scale Effects Trade and Competition Policies. Prof. Dr. Herbert Brücker. Last Lecture. Preferential Trade Liberalisation The PTA Diagram Free Trade Equilibrium

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Theorie und Politik der Europäischen Integration

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  1. Theorie und Politik der Europäischen Integration • Theory and Politics of European Integration Lecture 4 Market Size and Scale Effects Trade and Competition Policies • Prof. Dr. Herbert Brücker

  2. Last Lecture Theory and Politics of European Integration Lecture 5 Preferential Trade Liberalisation • 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

  3. Uniform MFN Tariff Theory and Politics of European Integration Lecture 3 Preferential Trade Liberalisation • MSMFN • Domestic price • Home • Border • price • Border • price • RoW • Partner • XSP • MS • XSR • P’ • T • P • P’-T • Pa • T • MD • p* • XR’ • XR • Partner • Exports • RoW • Exports • Home • imports • M’ • XP’ • XP • MFREE

  4. Discriminatory, Unilateral Liberalization Theory and Politics of European Integration Lecture 3 Preferential Trade Liberalisation • MSMFN • Domestic price • Home • Border • price • Border • price • RoW • Partner • MSPTA • XSP • MS • XSR • P’ • P” • P” • T • P’-T • P”-T • Pa • 1 • T • MD • p* • Partner • Exports • RoW • Exports • Home • imports • M’ • XP’ • XP” • M” • XR” • XR’

  5. Domestic Price and Border Price Changes Theory and Politics of European Integration Lecture 3 Preferential Trade Liberalisation • Border price • Border price • Domestic price • MSMFN • XSP • XSR • MSPTA • MS • P’ • P” • P” • T • P’-T • P’-T • P”-T • MD • XR” • XR’ • XP’ • XP” • M’ • M” • Home • imports • Partner • Exports • RoW • Exports

  6. Domestic Price and Border Price Changes Theory and Politics of European Integration Lecture 3 Preferential Trade Liberalisation • Border price • Border price • Domestic price • MSMFN • XSP • XSR • MSPTA • MS • P’ • P” • P” • T • P’-T • P’-T • P”-T • domestic price falls to P’’ from P’ • MD • XR” • XR’ • XP’ • XP” • M’ • M” • Home • imports • Partner • Exports • RoW • Exports

  7. Domestic Price and Border Price Changes Theory and Politics of European Integration Lecture 3 Preferential Trade Liberalisation • Border price • Border price • Domestic price • MSMFN • XSP • XSR • MSPTA • MS • P’ • P” • P” • T • P’-T • P’-T • P”-T • domestic price falls to P’ from P” • Partner-based firms • see border price rise, • from P’-T to P” • MD • XR” • XR’ • XP’ • XP” • M’ • M” • Home • imports • Partner • Exports • RoW • Exports

  8. Domestic Price and Border Price Changes Theory and Politics of European Integration Lecture 3 Preferential Trade Liberalisation • Border price • RoW firms see • border price • fall from • P’-T to P”-T. • Border price • Domestic price • MSMFN • XSP • XSR • MSPTA • MS • P’ • P” • P” • T • P’-T • P’-T • P”-T • domestic price falls to P’ from P” • Partner-based firms • see border price rise, • P’-T to P” • MD • XR” • XR’ • XP’ • XP” • M’ • M” • Home • imports • Partner • Exports • RoW • Exports

  9. Border price • Border price • Domestic price • MSMFN • XSP • XSR • MSPTA • MS • P’ • P” • P” • T • P’-T • P’-T • P”-T • MD • XR” • XR’ • XP’ • XP” • M’ • M” • Home • imports • Partner • Exports • RoW • Exports Quantity Changes: Supply Switching Theory and Politics of European Integration Lecture 3 Preferential Trade Liberalisation

  10. Border price • Border price • Domestic price • MSMFN • XSP • XSR • MSPTA • MS • P’ • P” • P” • T • P’-T • P’-T • P”-T • MD • XR” • XR’ • XP’ • XP” • M’ • M” • Home • imports • Partner • Exports • RoW • Exports Quantity Changes: Supply Switching Theory and Politics of European Integration Lecture 3 Preferential Trade Liberalisatio • RoW exports fall

  11. Today's Lecture - Overview Theory and Politics of European Integration Lecture 5 Preferential Trade Liberalisation • Market Size and Scale Effects • EU Competition Policies • EU Trade Policies

  12. Today's Reading Theory and Politics of European Integration Lecture 5 Preferential Trade Liberalisation • Market Size and Scale Effects • Baldwin & Wyplosz (2009) “The Economics of European Integration”, McGraw-Hill, Ch 6. • Competitionand State AidPolicies • Baldwin & Wyplosz (2009) “The Economics of European Integration”, McGraw-Hill, Ch 14. • Trade Policies • Baldwin & Wyplosz (2009) “The Economics of European Integration”, McGraw-Hill, Ch 15.

  13. Market Size Matters Theory and Politics of European Integration Lecture 5 Preferential Trade Liberalisation • 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.’

  14. Sketch of economic logic Theory and Politics of European Integration Lecture 5 Preferential Trade Liberalisation • liberalisation  • de-fragmentation  • pro-competitive effect  • industrial restructuring (M&A, etc.) • RESULT: fewer, bigger, more efficient firms facing more effective competition from each other.

  15. Sketch of economic logic Theory and Politics of European Integration Lecture 5 Preferential Trade Liberalisation • liberalisation  • de-fragmentation  • pro-competitive effect  • industrial restructuring (M&A, etc.) • RESULT: fewer, bigger, more efficient firms facing more effective competition from each other.

  16. Monopolies and duopolies Theory and Politics of European Integration Lecture 5 Preferential Trade Liberalisation • Firms are not price takes • Elasticity of demand curve constrains price levels • Profit maximum is achieved if prices are chosen in a way that marginal revenues equal marginal costs • Duopoly: Price and production depends on expectations on behaviour of competitors • Cournot-Nash equilibrium: Optimum is achieved when symmetric firms produce same level of output

  17. Economic logic (background): Monopoly case Theory and Politics of European Integration Lecture 5 Preferential Trade Liberalisation • Demand • Curve • Price • Price • Marginal Revenue • Curve • Marginal • Cost Curve • Demand • Curve • P* • P’ • A • P” • B • D • Marginal • Cost • C • E • Q’ • Q’+1 • Q* • Sales • Sales

  18. Economic logic (background): Monopoly case Theory and Politics of European Integration Lecture 5 Preferential Trade Liberalisation • Demand • Curve • Price • Price • Marginal Revenue • Curve • Demand • Curve • P* • Marginal • Cost Curve • P’ • A • P” Extra revenuesofoneunit: D + E – A. „marginal revenue“ • B • D • Marginal • Cost • C • E • Q’ • Q’+1 • Q* • Sales • Sales

  19. Economic logic (background): Monopoly case Theory and Politics of European Integration Lecture 5 Preferential Trade Liberalisation • Demand • Curve • Price • Price • Marginal Revenue • Curve • Demand • Curve • P* • Marginal • Cost Curve • P’ • A Profitmaximum: marginal revenueequals marginal costs. • P” • B • D • Marginal • Cost • C • E • Q’ • Q’+1 • Q* • Sales • Sales

  20. Duopoly case, example of non-equilbrium Theory and Politics of European Integration Lecture 5 Preferential Trade Liberalisation • 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)

  21. Duopoly and oligopoly case, equilbrium outcome Theory and Politics of European Integration Lecture 5 Preferential Trade Liberalisation • 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

  22. Bringing this to trade Theory and Politics of European Integration Lecture 5 Preferential Trade Liberalisation • Brander and Krugman (1983) • Building on Nash they combine increasing returns to scale, imperfect competition and trade • Presentation of theory here in Breakeven-Competition (BE-COMP)-Diagram

  23. Mark-up (m) • mmono • mduo • BE (break-even) curve • m’ • COMP • curve • n’ • n=2 • n=1 • Number of firms Breakeven-Competion (BE-COMP) Diagram Theory and Politics of European Integration Lecture 5 Preferential Trade Liberalisation

  24. Mark-up (m) • mmono • mduo • BE (break-even) curve • m’ • COMP • curve • n’ • n=2 • n=1 • Number of firms Breakeven-Competion (BE-COMP) Diagram Theory and Politics of European Integration Lecture 5 Preferential Trade Liberalisation Markup (µ): Price markupovercosts, depends on competition

  25. Mark-up (m) • mmono • mduo • BE (break-even) curve • m’ • COMP • curve • n’ • n=2 • n=1 • Number of firms Breakeven-Competion (BE-COMP) Diagram Theory and Politics of European Integration Lecture 5 Preferential Trade Liberalisation Breakeven (BE) curve: Withincreasingreturnstoscaleonly a limited numberoffirmscansurvive. Survivaldepends on markup µ.

  26. Details of COMP curve Theory and Politics of European Integration Lecture 5 Preferential Trade Liberalisation • 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 • n=1 • n=2 • R-MR • MR (monopoly) • Typical firm’s sales • xduo • xmono

  27. Details of BE curve: closed economy Theory and Politics of European Integration Lecture 5 Preferential Trade Liberalisation • Mark-up • (i.e., p-MC) • euros • price • Home market • po=mo+MC • BE • Demand curve • A • ACo=po • B • A • po • mo • B • COMP • AC • MC • n” • no • n’ • Sales • per firm • Total • sales • Co • x”=Co/n” • x’=Co/n’ • xo=Co/no

  28. Outline of BE-COMP Diagram Theory and Politics of European Integration Lecture 7 Trade and Competition Policies • euros • price • Mark-up • Home market • COMP curve • Average cost curve • Demand curve • Demand curve • BE • E’ • 1 • E’ • E’ • m' • p’ • p’ • E” • C • E” • E” • p” • p” • A • A • mA • pA • AC • MC • n’ • n” • 2n’ • Sales • per firm • x” • Total • sales • C’ • C” • x’

  29. Outline of BE-COMP Diagram Theory and Politics of European Integration Lecture 7 Trade and Competition Policies • euros • price • Mark-up • Home market • COMP curve • Average cost curve • Demand curve • Demand curve • BE • Average cost of representative firm equals price after adjustment of firm number • E’ • 1 • E’ • E’ • m' • p’ • p’ • E” • C • E” • E” • p” • p” • A • A • mA • pA • AC • MC • n’ • n” • 2n’ • Sales • per firm • x” • Total • sales • C’ • C” • x’

  30. Outline of BE-COMP Diagram Theory and Politics of European Integration Lecture 7 Trade and Competition Policies • euros • price • Mark-up • Home market • COMP curve • Average cost curve • Demand curve • Demand curve • BE • Competition curve shows combination of mark-up and equilibrium firm number • Average cost of representative firm equals price after adjustment of firm number • E’ • 1 • E’ • E’ • m' • p’ • p’ • E” • C • E” • E” • p” • p” • A • A • mA • pA • AC • MC • n’ • n” • 2n’ • Sales • per firm • x” • Total • sales • C’ • C” • x’

  31. Outline of BE-COMP Diagram Theory and Politics of European Integration Lecture 7 Trade and Competition Policies • euros • price • Mark-up • Home market • COMP curve • Average cost curve • Demand curve • Demand curve • BE • Breakeven curve is upward sloping, since sales per firm fall with increasing firm number such that higher mark-up is needed to breakeven • Average cost of representative firm equals price after adjustment of firm number • E’ • 1 • E’ • E’ • m' • p’ • p’ • E” • C • E” • E” • p” • p” • A • A • mA • pA • AC • MC • n’ • n” • 2n’ • Sales • per firm • x” • Total • sales • C’ • C” • x’

  32. Addressing European integration Theory and Politics of European Integration Lecture 5 Preferential Trade Liberalisation • Assume that trade-to-non trade liberalization provides (i) each firm with a market of twice its side and (ii) double the number of firms in each market • What happens to markup, equilibrium number of firms, average costs, price and demand?

  33. No-trade-to-free-trade integration Theory and Politics of European Integration Lecture 7 Trade and Competition Policies • euros • price • Mark-up • Home market • After integration, each firm has (i) second market of same size and (ii) twice the number of competitors • Average cost curve • Demand curve • BE • E’ • 1 • E’ • E’ • m' • p’ • p’ • E” • C • E” • E” • p” • p” • A • A • mA • pA • AC • MC • n’ • n” • 2n’ • Sales • per firm • x” • Total • sales • C’ • C” • x’

  34. No-trade-to-free-trade integration Theory and Politics of European Integration Lecture 7 Trade and Competition Policies • euros • price • Mark-up • Home market • Average cost curve • Demand curve • BE • Competition effect: number of firms is 2n’, such that mark-up declines to A at given firm number. • E’ • 1 • E’ • E’ • m' • p’ • p’ • E” • C • E” • E” • p” • p” • A • A • mA • pA • AC • MC • n’ • n” • 2n’ • Sales • per firm • x” • Total • sales • C’ • C” • x’

  35. No-trade-to-free-trade integration Theory and Politics of European Integration Lecture 7 Trade and Competition Policies • euros • price • Mark-up • Home market • Market size effect: BE curve shifts to outward to the right. At given number of firms (point 1) we have no equilibrium). • Average cost curve • Demand curve • BE • E’ • 1 • E’ • E’ • m' • p’ • p’ • E” • C • E” • E” • p” • p” • A • A • mA • pA • AC • MC • n’ • n” • 2n’ • Sales • per firm • x” • Total • sales • C’ • C” • x’

  36. No-trade-to-free-trade integration Theory and Politics of European Integration Lecture 7 Trade and Competition Policies • euros • price • Mark-up • Home market • Smaller mark-up and higher competition reduces prices to pA. Below breakeven point for given number of firms. Industrial restructuring results in E’’ equilibrium number of firms. • Average cost curve • Demand curve • BE • E’ • 1 • E’ • E’ • m' • p’ • p’ • E” • C • E” • E” • p” • p” • A • A • mA • pA • AC • MC • n’ • n” • 2n’ • Sales • per firm • x” • Total • sales • C’ • C” • x’

  37. No-trade-to-free-trade integration Theory and Politics of European Integration Lecture 7 Trade and Competition Policies • euros • price • Mark-up • Home market • Since each firm has a larger market in new equilibrium, average costs decline. Efficiency gain. • Average cost curve • Demand curve • BE • E’ • 1 • E’ • E’ • m' • p’ • p’ • E” • C • E” • E” • p” • p” • A • A • mA • pA • AC • MC • n’ • n” • 2n’ • Sales • per firm • x” • Total • sales • C’ • C” • x’

  38. No-trade-to-free-trade integration Theory and Politics of European Integration Lecture 7 Trade and Competition Policies • euros • price • Mark-up • Home market • Average cost curve • Demand curve • BE • Welfare gain: C. Consumer benefit from (i) lower prices, (ii) higher consumption. • E’ • 1 • E’ • E’ • m' • p’ • p’ • E” • C • E” • E” • p” • p” • A • A • mA • pA • AC • MC • n’ • n” • 2n’ • Sales • per firm • x” • Total • sales • C’ • C” • x’

  39. Economic logic Theory and Politics of European Integration Lecture 5 Preferential Trade Liberalisation • Integration: no-trade-to-free-trade: BE curve shifts out (to point 1). (Larger market effect) • 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.

  40. Economic logic (cont.) Theory and Politics of European Integration Lecture 5 Preferential Trade Liberalisation • 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”.

  41. Facts Theory and Politics of European Integration Lecture 5 Preferential Trade Liberalisation • 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%). • Empirical evidence: Single Market Programme reduced Price-Cost Margins by 4 per cent on average. • High variance: • - 15 per cent in office equipment sector • -0.1 per cent in brewing

  42. Facts Theory and Politics of European Integration Lecture 5 Preferential Trade Liberalisation • 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 high share of M&A. • This picture fits pretty well into theoretical expectations: Small countries suffer more from fragmentation of markets such that pressure for industrial restructuring is higher compared to countries with a larger market share

  43. Facts Theory and Politics of European Integration Lecture 5 Preferential Trade Liberalisation

  44. Facts Theory and Politics of European Integration Lecture 5 Preferential Trade Liberalisation • 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.

  45. EU Competition and State Aid Policy Theory and Politics of European Integration Lecture 7 Trade and Competition Policies

  46. Competition and subsidies Theory and Politics of European Integration Lecture 5 Preferential Trade Liberalisation • 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 14, 3rd Edition.

  47. EU Competition Policy Theory and Politics of European Integration Lecture 7 Trade and Competition Policies • Exclusive competency of EU; Commission controls. • 2 aspects: mergers & anti-competitive behaviour. • Economic integration yields less firms, higher concentration but more cross-border competition • Creates incentives to collude and undertake anti-competitive measures • Look at justification for putting competition policy at the EU level

  48. Anti-competitive behaviour Theory and Politics of European Integration Lecture 7 Trade and Competition Policies • Collusion is a real concern in Europe. • dangers of collusion rise as the number of firms falls. • Collusion in the BE-COMP diagram • COMP curve is for ‘normal’, non-collusive competition • Firms do not coordinate prices or sales • Other extreme is ‘perfect collusion’ • Firms coordinate prices and sales perfectly • Max profit from market is monopoly price & sales • Perfect collusion is where firms charge monopoly price and split the sales among themselves

  49. Economic effects Theory and Politics of European Integration Lecture 7 Trade and Competition Policies • Consider two cases: • Perfect collusion: • Firms set prices to monopoly level and divide profits equally. • Price increases. • Markup increases. • More firms enter market. • Eventually, zero profit condition restored, i.e. price equals average costs. • Mark-up • BEFT • mmono • A • B • mB • E” • m” • COMP • nP’ • Number of firms • n=1 • n” • nB • 2n’

  50. Economic effects Theory and Politics of European Integration Lecture 7 Trade and Competition Policies • Partial collusion • Less opportunities to cheat • 2n’ is too high for all firms to break even. • Industrial consolidation proceeds as usual, but only to nB. • Zero profits earned by all at point B. • Prices higher, pB> p”, smaller firms, higher average cost. • Mark-up • BEFT • mmono • A • B • mB • E” • m” • COMP • Number of firms • n=1 • n” • nB • 2n’

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