Theorie und Politik der
Europäischen Integration
Theory and Politics of
European Integration
Lecture 6
Market Size and Scale Effects
Prof. Dr. Herbert Brücker
Theory and Politics of European Integration
Lecture 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 | [email protected] | www.uni-bamberg.de/sowi/bruecker
Theory and Politics of European Integration
Lecture 5
Today's Lecture - Overview
•
Market Size and Scale Effects
Prof. Dr. Herbert Brücker
Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte
Universität Bamberg | [email protected] | www.uni-bamberg.de/sowi/bruecker
Preferential Trade Liberalisation
Theory and Politics of European Integration
Lecture 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 | [email protected] | www.uni-bamberg.de/sowi/bruecker
Theory and Politics of European Integration
Lecture 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 | [email protected] | www.uni-bamberg.de/sowi/bruecker
Theory and Politics of European Integration
Lecture 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 | [email protected] | www.uni-bamberg.de/sowi/bruecker
Theory and Politics of European Integration
Lecture 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 | [email protected] | www.uni-bamberg.de/sowi/bruecker
Theory and Politics of European Integration
Lecture 5
Preferential Trade Liberalisation
Facts
M&A activity by nation, 1991-2002
B, 2.8%
UK, 31.4%
DK, 2.6%
EL, 1.1%
S, 5.3%
IRL, 1.7%
NL, 6.5%
L, 0.5%
I, 6.2%
A, 2.1%
P, 1.2%
F, 13.5%
D, 16.3%
E, 5.0%
Prof. Dr. Herbert Brücker
Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte
Universität Bamberg | [email protected] | www.uni-bamberg.de/sowi/bruecker
FIN, 3.9%
Theory and Politics of European Integration
Lecture 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 | [email protected] | www.uni-bamberg.de/sowi/bruecker
Theory and Politics of European Integration
Lecture 5
Preferential Trade Liberalisation
New Trade
Trade Theory:
Theory: A
A History
History of
of Ideas
Ideas (I/V)
New
• Traditional Trade Theory I: Ricardo Model
• Explains trade by comparative advantage in production, mainly
productivity differences
• Each country exports goods where it has a comparative
advantage in production, i.e. where its relative productivity is
below that of trading partner
• Each country imports goods where it has a comparative
disadvantage, i.e. where its relative productivity is below that of
trading partner
• Don’t confuse with absolute advantage!
• Traditional Trade Theory II: Heckscher-Olin Model
• Explains trade by differences in relative factor endowments
(land, capital labour)
• Each country exports goods which use relatively abundant
factor intensively in production
• Each country imports goods which use relatively scarce factor
intensively in production
Prof. Dr. Herbert Brücker
Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte
Universität Bamberg | [email protected] | www.uni-bamberg.de/sowi/bruecker
Theory and Politics of European Integration
Lecture 5
Preferential Trade Liberalisation
New Trade
Trade Theory:
Theory: A
A History
History of
of Ideas
Ideas (II/V)
New
• Empirical knowledge
• Limited until 1970s, no big data sets available, no computers
• Boost in empirical research in 1970s
• Two stylized facts:
• (i) Net trade pattern supports factor abundance hypothesis
• (ii) Overwhelming share of world trade is intra-industry trade,
i.e. trade in goods of same industries and which use same
factors intensively (Grubel/Lloyd 1974)
• Heckscher-Olin model expects that mainly countries trade which
differ in factor endowments
• Ricardo model expects that technology differences drive trade
• Actually, the overwhelming share of world trade is between
countries which have same factor endowments and apply similar
technologies
• Thus, traditional trade theories cannot explain intra-industy trade
Prof. Dr. Herbert Brücker
Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte
Universität Bamberg | [email protected] | www.uni-bamberg.de/sowi/bruecker
Theory and Politics of European Integration
Lecture 5
Preferential Trade Liberalisation
New Trade
Trade Theory:
Theory: A
A History
History of
of Ideas
Ideas (III/V)
New
• Grubel & Lloyd expect that increasing returns to scale are main
cause of intra-industry trade
• Basic idea is simple:
• If you have increasing returns to scale, it makes sense to locate the
production of one variety of a good in one country, which is
consumed by the domestic country and the trading partner. Another
variety in produced in another country, such that two countries with
similar factor endowments and technologies exchange goods if
consumer preferences are similar.
Prof. Dr. Herbert Brücker
Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte
Universität Bamberg | [email protected] | www.uni-bamberg.de/sowi/bruecker
Theory and Politics of European Integration
Lecture 5
Preferential Trade Liberalisation
New Trade
Trade Theory:
Theory: A
A History
History of
of Ideas
Ideas (IV/V)
New
• Development of microeconomic tools: Dixit-Stiglitz and Lancaster
explain develop methods to include increasing returns to scale in
general equilibrium models in late 1970s
• Trade theorists demonstrate that increasing returns to scale and/or
imperfect competition results necessarily in intra-industry trade in
late 1970s and 1980s (Krugman, Brandner, Lancaster, Helpman)
• These models are called “New Trade Theory”: Idea was long around,
but no tools available to demonstrate rigorously
• Thus, key difference to old theory is that assumption of constant
returns to scale and perfect competition is replaces by increasing
returns to scale and imperfect competition which enables us to
explain intra-industry trade between countries
• Important for European integration: market size matters!
Prof. Dr. Herbert Brücker
Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte
Universität Bamberg | [email protected] | www.uni-bamberg.de/sowi/bruecker
Theory and Politics of European Integration
Lecture 5
Preferential Trade Liberalisation
New Trade
Trade Theory:
Theory: A
A History
History of
of Ideas
Ideas (V/V)
New
Main contributions:
• Paul Krugman, 1979, 1980, 1981 articles.
• Jim Brander, PhD thesis in late 1970s, 1982, 1984 articles
(with Krugman) & strategic trade policies (with Barbara
Spencer) in 1980s.
• Elhanan Helpman, 1981 article and 1985, 1989 books (with
Krugman). Further articles on multinational firms in 1980s
and 1990s.
• Jim Markusen, 1980 article and article on multinationals in
1984.
Prof. Dr. Herbert Brücker
Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte
Universität Bamberg | [email protected] | www.uni-bamberg.de/sowi/bruecker
Theory and Politics of European Integration
Lecture 5
Preferential Trade Liberalisation
New Trade
Trade Theory:
theory: A History of Ideas
New
Outline of Krugman’s workhorse model
• Ricardo, Ricardo-Viner & HO models consider differences across
countries as cause for trade
• Krugman model explains trade by geographical concentration of
production of varieties of goods
• trade = produce in one country and sale in another one
• Internal IRS explain geographical concentration of production
• Limited resources and imperfect competition explain why different
countries produce different variety of a good
· One country cannot produce all varieties (resource constraint)
· Every firm produces only one variety in order to avoid direct
competition
• Every country produces only one variety but buys all varieties,
such that we have intra industry trade between similar countries
Prof. Dr. Herbert Brücker
Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte
Universität Bamberg | [email protected] | www.uni-bamberg.de/sowi/bruecker
Theory and Politics of European Integration
Lecture 5
Preferential Trade Liberalisation
First Trade
key element:
returns
New
Theory:Increasing
A History of
Ideas to scale
• Internal returns to scale, i.e.
average costs of production (AC)
fall with increasing production
within one firm
• External returns to scale, i.e. AC
of production fall with increasing
production of sector (or region),
but own AC are assumed to be
constant because own contribution to total production is small
• Internal and external returns to
scale have different
consequences, therefore different
models. Here: internal returns to
scale.
Prof. Dr. Herbert Brücker
Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte
Universität Bamberg | [email protected] | www.uni-bamberg.de/sowi/bruecker
Theory and Politics of European Integration
Lecture 5
Preferential Trade Liberalisation
Second
keyTheory:
element:
New
Trade
A imperfect
History of competition
Ideas
• External increasing returns to scale can be treated in perfect
competition framework. Simple but covers only small part of real
world phenomenon
• Internal increasing returns to scale need imperfect competition
• What implies internal returns to scale:
• Average costs (AC) > marginal costs (MC)
• If price (P) equals marginal costs, the firms makes losses:
P = MC < AC
• Thus, we need P > MC to make non-negative profits
• However, P > MC requires imperfect competition.
Prof. Dr. Herbert Brücker
Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte
Universität Bamberg | [email protected] | www.uni-bamberg.de/sowi/bruecker
Theory and Politics of European Integration
Lecture 5
Preferential Trade Liberalisation
Simple
Imperfect
Competition
New
Trade
Theory:
A History ofTheory
Ideas
• Most simple framework: Monopolistic competition or Dixit-Stiglitz
framework
• Each firm is monopolistic supplier of one variety of a good
• Faces fixed set-up costs, which result in declining average costs
if production increases
• Product demand declines with price, since can substitute this
variety of a good by another one
• Why simple?
• No strategic interaction between firms.
• Main elements can be treated as in simple monopoly case.
• We start with closed economy setting to outline ideas.
Prof. Dr. Herbert Brücker
Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte
Universität Bamberg | [email protected] | www.uni-bamberg.de/sowi/bruecker
Theory and Politics of European Integration
Lecture 5
Preferential Trade Liberalisation
Economic logic: Monopoly case (closed economy)
Price
P’
P”
Price
Demand
Curve
Marginal P*
Cost Curve
A
B
C
Marginal Revenue
Curve
Demand
Curve
D
Marginal
Cost
E
Q’ Q’+1
Sales
Prof. Dr. Herbert Brücker
Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte
Universität Bamberg | [email protected] | www.uni-bamberg.de/sowi/bruecker
Q*
Sales
Theory and Politics of European Integration
Lecture 5
Preferential Trade Liberalisation
Economic logic: Monopoly case (closed economy)
Price
P’
P”
Price
Demand
Curve
Marginal P*
Cost Curve
A
B
C
Marginal Revenue
Curve
Demand
Curve
What is the marginal revenue
curve?
D
price for first unit – Q times
change in price
Marginal
Cost
E
Q’ Q’+1
Sales
Prof. Dr. Herbert Brücker
Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte
Universität Bamberg | [email protected] | www.uni-bamberg.de/sowi/bruecker
Q*
Sales
Theory and Politics of European Integration
Lecture 5
Preferential Trade Liberalisation
Economic logic: Monopoly case (closed economy)
Marginal revenue curve is always
below average cost curve!
Price
P’
P”
Price
Demand
Curve
Marginal P*
Cost Curve
A
B
C
Marginal Revenue
Curve
Demand
Curve
D
Marginal
Cost
E
Q’ Q’+1
Sales
Prof. Dr. Herbert Brücker
Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte
Universität Bamberg | [email protected] | www.uni-bamberg.de/sowi/bruecker
Q*
Sales
Theory and Politics of European Integration
Lecture 5
Preferential Trade Liberalisation
Economic logic: Monopoly case (closed economy)
Price, p
MC
pMC
AC
Demand
Marginal Revenue (MC)
qMC
Prof. Dr. Herbert Brücker
Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte
Universität Bamberg | [email protected] | www.uni-bamberg.de/sowi/bruecker
Output, q
Theory and Politics of European Integration
Lecture 5
Preferential Trade Liberalisation
Monopolistic
Competition
New
Trade Theory:
A History of Ideas
• Monopolistic competition is a market form, where each firm is a
monopolistic supplier of one variety of a good, which is a close
substitute to another variety, but still different (“imperfect
substitutes”)
• Every firm takes the price of all other firms as given. Its behavior
can therefore described as one of a monopolist for the remaining
demand
• Each firm faces fixed set-up costs, which result in declining average
costs if production increases
• What happens if new firms entry market?
• Residual demand of all other firms always declines
• Residual demand curve becomes flatter, since the remaining
varieties become closer substitutes from the consumer’s
perspective
• Does not hold necessarily for all goods
Prof. Dr. Herbert Brücker
Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte
Universität Bamberg | [email protected] | www.uni-bamberg.de/sowi/bruecker
Theory and Politics of European Integration
Lecture 5
Preferential Trade Liberalisation
The Residual Demand-Marginal Revenue Diagram
Price
• Profit-maximizing firms fix
prices and production under
monopolistic competition
such that marginal
P*
revenues equal marginal
costs, i.e. at point Q*.
P’
• Note that marginal
revenues depend on
residual demand curve
(RD).
• Differences between
marginal costs and price is
called as markup.
RD
RD’
MR
MR’
Q’ Q*
Prof. Dr. Herbert Brücker
Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte
Universität Bamberg | [email protected] | www.uni-bamberg.de/sowi/bruecker
MC
Sales
Theory and Politics of European Integration
Lecture 5
Preferential Trade Liberalisation
WhatTrade
happens
at market
entry
new firms?
New
Theory:
A History
ofof
Ideas
• Market entry shifts Residual Demand (RD) curve downward.
• Consequently, Marginal Revenue (MR) Curve moves downward
and gets flatter.
• As a result, firms have to reduces markup between prices and
marginal costs, i.e. prices and profits fall.
• Two examples: Duopoly and Oligopoly.
Prof. Dr. Herbert Brücker
Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte
Universität Bamberg | [email protected] | www.uni-bamberg.de/sowi/bruecker
Theory and Politics of European Integration
Lecture 5
Preferential Trade Liberalisation
Duopoly case, example of non-equilibrium
price
price
Firm 1’s expectation of
sales by firm 2, Q2
p1’
Firm 2’s expectation of
sales by firm 1, Q1
Demand
Curve (D)
p2’
Residual Demand
Curve firm 1 (RD1)
A1
MC
x1’
Firm 1 sales
Residual Marginal Revenue
Prof. Dr. Herbert Brücker
Curve firm
1 (RMR1)
Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte
Demand
Curve (D)
Residual Demand
Curve firm 2 (RD2)
A2
x2’
Residual Marginal Revenue
Curve firm 2 (RMR2)
Universität Bamberg | [email protected] | www.uni-bamberg.de/sowi/bruecker
MC
Firm 2 sales
Theory and Politics of European Integration
Lecture 5
Preferential Trade Liberalisation
Duopoly and oligopoly case, equilibrium outcome
price
Typical firm’s expectation
of the other firm’s sales price
p*
Typical firm’s expectation
of other the other firms’
sales
D
D
p**
RD
RD’
A
MC
A
RMR
x*
Duopoly
MC
RMR’
2x* sales
Prof. Dr. Herbert Brücker
Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte
Universität Bamberg | [email protected] | www.uni-bamberg.de/sowi/bruecker
x**
Oligopoly
sales
3x**
Theory and Politics of European Integration
Lecture 5
Preferential Trade Liberalisation
The PP-CC or the BE-COMP Diagram
• In his book, Krugman (1984) uses maths to make these basic
points about increasing returns to scale and imperfect competition
• You can skip the math and just read it for ideas
• Rely on the previous diagram to motivate why more firms leads to
lower prices – this is, after all, a very intuitive outcome (more
competition, lower prices).
• To determines the equilibrium number of firms we introduce two
curves: The PP or COMP curve and the CC or Break even curve.
Prof. Dr. Herbert Brücker
Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte
Universität Bamberg | [email protected] | www.uni-bamberg.de/sowi/bruecker
Theory and Politics of European Integration
Lecture 5
Preferential Trade Liberalisation
Krugman’s CC-PP Diagram
BE
COMP
Prof. Dr. Herbert Brücker
Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte
Universität Bamberg | [email protected] | www.uni-bamberg.de/sowi/bruecker
Theory and Politics of European Integration
Lecture 5
Preferential Trade Liberalisation
Breakeven-Competition (BE-COMP) Diagram
Mark-up (m)
mmono
mduo
BE (break-even) curve
m’
COMP
curve
n=1 n=2
n’
Prof. Dr. Herbert Brücker
Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte
Universität Bamberg | [email protected] | www.uni-bamberg.de/sowi/bruecker
Numb
er of
firms
Theory and Politics of European Integration
Lecture 5
Preferential Trade Liberalisation
Determination of equilibrium number of firms
• CC- or breakeven (BE) curve gives number of firms which
breakeven, i.e. make zero or higher profits at given number of
firms in market
• Sales of firm fall with increasing n, such that firms need higher
price on product market to breakeven
• While CC- or BE-curve shows which price is requested to
breakeven, the PP or COMP curve presents price maximum at
given competition of firms
• At cut-off point of PP/BE and CC/BE curves, firms request profitmaximizing prices and just breakeven, i.e. price equals average
costs (P=AC)
Prof. Dr. Herbert Brücker
Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte
Universität Bamberg | [email protected] | www.uni-bamberg.de/sowi/bruecker
Theory and Politics of European Integration
Lecture 5
Preferential Trade Liberalisation
Details
of COMP curve
price
p'
mmono
A’
p"
mduo
B’
D
Monopoly
mark-up
Duopoly
mark-up
MC
COMP
curve
R-D (duopoly)
B
Marginal cost
curve
A
R-MR
MR (monopoly)
Prof. Dr. Herbert Brücker
Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte
duo
mono
Universität Bamberg | [email protected] | www.uni-bamberg.de/sowi/bruecker
x
x
n=1
Typical firm’s sales
n=2
Theory and Politics of European Integration
Lecture 5
Preferential Trade Liberalisation
Details of BE curve
euros
price
Mark-up
(i.e., p-MC)
Home market
po=mo+MC
BE
Demand curve
A
ACo=po
mo
po
B
A
B
AC
MC
Sales
per firm
x’= Co/n’
x”= Co/n”
Prof. Dr. Herbert Brücker
o für Volkswirtschaftslehre,
o o
Lehrstuhl
insbesondere Integration Europäischer Arbeitsmärkte
Universität Bamberg | [email protected] | www.uni-bamberg.de/sowi/bruecker
x = C /n
n” no
Co
Total
sales
n’
Theory and Politics of European Integration
Lecture 5
Preferential Trade Liberalisation
Implications of monopolistic competition for trade
(Krugman’s model)
• In the models we have two-way trade between identical countries
• “Krugman model of trade” (Krugman JIE 1979, AER 1980, JPE
1981)
• We have only intra-industry trade
• Domestic countries exports varieties of an industrial good to
foreign country and vice versa
• Two sources of gains from trade: scale effects and procompetitive effects
Prof. Dr. Herbert Brücker
Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte
Universität Bamberg | [email protected] | www.uni-bamberg.de/sowi/bruecker
Theory and Politics of European Integration
Lecture 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 | [email protected] | www.uni-bamberg.de/sowi/bruecker
Theory and Politics of European Integration
Lecture 5
Preferential Trade Liberalisation
Recall: autarky equilibrium
euros
price
Mark-up
Home market
Demand curve
E’
p’
BE
E’
p’
m'
E’
C
mA
AC
MC
x’
Sales
per firm
Prof. Dr. Herbert Brücker
Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte
Universität Bamberg | [email protected] | www.uni-bamberg.de/sowi/bruecker
n’
C’
Total
sales
Theory and Politics of European Integration
Lecture 5
Preferential Trade Liberalisation
No-trade-to-free-trade integration
euros
price
Mark-up
Home market
Demand curve
p’
p”
E’
E’
p’
E”
p”
BE
C
m'
E’
E”
E”
A
pA
1
mA
A
AC
MC
x’ x”
Sales
per firm
Prof. Dr. Herbert Brücker
Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte
Universität Bamberg | [email protected] | www.uni-bamberg.de/sowi/bruecker
n’
C’ C”
Total
sales
n”
2n’
Theory and Politics of European Integration
Lecture 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 pA.
Prof. Dr. Herbert Brücker
Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte
Universität Bamberg | [email protected] | www.uni-bamberg.de/sowi/bruecker
Theory and Politics of European Integration
Lecture 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 | [email protected] | www.uni-bamberg.de/sowi/bruecker
Theory and Politics of European Integration
Lecture 5
Preferential Trade Liberalisation
Why do prices fall under zero profit condition?
• Existence of internal returns
to scale is the key to falling
prices
• Each of the n2 firms sales
more than under autarky
• Therefore, AC are lower
than under autarky
• This implies, they can
request (and will request)
lower prices to break-even
• Constraint: zero profits
under monopolistic
competition imply that
prices equal average costs
(P=AC).
euros
p’
E’
E”
p”
AC
MC
x’ x”
Prof. Dr. Herbert Brücker
Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte
Universität Bamberg | [email protected] | www.uni-bamberg.de/sowi/bruecker
Firm-level
output
Theory and Politics of European Integration
Lecture 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, 2nd Edition.
Prof. Dr. Herbert Brücker
Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte
Universität Bamberg | [email protected] | www.uni-bamberg.de/sowi/bruecker
Theory and Politics of European Integration
Lecture 5
NEXT LECTURE
• November 27
Prof. Dr. Herbert Brücker
Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte
Universität Bamberg | [email protected] | www.uni-bamberg.de/sowi/bruecker
Preferential Trade Liberalisation