Chapter 6: Market Size and Scale Effects © Baldwin&Wyplosz The Economics of European Integration

© Baldwin&Wyplosz The Economics of European Integration 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 The Economics of European Integration

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 The Economics of European Integration

© Baldwin&Wyplosz The Economics of European Integration L’analisi avviene attraverso la costruzione di due curve La curva Comp mostra la relazione tra numero di imprese sul mercato e mark up (differenza fra prezzo e costo marginale) La curva BE mostra la relazione tra numero di imprese in Break Even (prezzo uguale costo medio) e mark up © Baldwin&Wyplosz The Economics of European Integration

© Baldwin&Wyplosz The Economics of European Integration BE-COMP diagram Mark-up (m) COMP curve BE (break-even) curve m’ n’ mmono mduo n=1 n=2 Number of firms Comp: n=1 ovvero monopolio m massimo Al crescere del numero di imprese il mark up si riduce (fino a zero in concorreza p=costo marginale BE: relazione crescente tra mark up e numero di imprese che riescono a stare sul mercato senza perdite . © Baldwin&Wyplosz The Economics of European Integration

Costruzione della curva BE Se non ci fosse nessuna relazione tra dimensione di impresa e costi medi di produzione non ci sarebbe nessuna relazione tra mark up e numero di imprese in pareggio sul mercato Se vi sono costi fissi, costi totali TC=A+cQ Costi medi AC=(A/Q)+c la curva del costo medio è sempre decrescente al crescere di Q e tende asintoticamente al costo marginale c Anche senza costi fissi la curva del costo medio è sempre decrescente in Q se i costi totali al crescere della quantità prodotta crescono in modo meno che proporzionale (costi marginali decrescenti, ovvero “rendimenti di scala” crescenti) © Baldwin&Wyplosz The Economics of European Integration

© Baldwin&Wyplosz The Economics of European Integration Nel grafico successivo vedete a sinistra una curva del costo medio decrescente. L’ipotesi è che sul mercato ci siano n imprese uguali con curva AC. Al prezzo p0 la domanda totale di mercato (curva di domanda nel secondo grafico) è C0 Ogni impresa per essere in pareggio al prezzo p0 (=AC0) deve produrre la quantità x0. Quindi il numero massimo di imprese in pareggio al prezzo p ovvero al mark up m0 è n0=C0/x0 Nel terzo grafico vedete la relazione tra il numero di imprese in pareggio e il mark up (l’asse verticale rappresenta solo il mark up perché l’origine è in corrispondenza di MC, costi marginali ) © Baldwin&Wyplosz The Economics of European Integration

© Baldwin&Wyplosz The Economics of European Integration Details of BE curve Mark-up (i.e., p-MC) euros price Home market po=mo+MC Demand curve BE A AC>po ACo=po B A po mo B AC<po AC MC n” no n’ Number of firms Sales per firm Co Total sales x”= Co/n” x’= Co/n’ xo= Co/no © Baldwin&Wyplosz The Economics of European Integration

Equilibrium in BE-COMP diagram euros Price Mark-up Home market Demand curve BE E’ E’ p’ p’ m' E’ AC COMP MC n’ Number of firms x’ Sales per firm C’ Total sales © Baldwin&Wyplosz The Economics of European Integration

© Baldwin&Wyplosz The Economics of European Integration Economic Logic Integration: no-trade-to-free-trade: BE curve shifts out (to point 1) Integrazione: da no commercio a commercio libero. La curva si sposta e passa nel punto 1 dove il mark up iniziale m’ adesso è compatibile con il doppio di imprese in pareggio 2n’ Defragmentation PRE typical firm has 100% sales at home, 0% abroad; POST: 50-50 Can’t see in diagram L’impresa tipica che prima vendeva il 100% del prodotto sul mercato interno ora vende 50-50 sui due mercati (ma questo non si vede nel diagramma) 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 Effetto pro competitivo: il mark scende, il nuovo equilibrio è in A dove però l’impresa tipica è in perdita (al di sotto della curva BE) © Baldwin&Wyplosz The Economics of European Integration

© Baldwin&Wyplosz The Economics of European Integration 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” Ristrutturazione industriale (III grafico a destra) da A a E” Numero di imprese da 2n’ to n”. Queste imprese hanno una quota di mercato e output più elevati e Le imprese sono più efficienti, il costo medio scende da AC da p’ a p”, Il mark-up aumenta Le imprese tornano in break even RISULTATO: meno imprese, più grandi,più efficienti, e più concorrenza. Prezzi più bassi © Baldwin&Wyplosz The Economics of European Integration

No-trade-to-free-trade integration euros price Mark-up Home market only Demand curve BE BEFT E’ E’ E’ 1 p’ p’ m' C E” E” E” p” p” A mA A pA AC COMP MC n’ n” 2n’ Number of firms x’ x” Sales per firm C’ C” Total sales © Baldwin&Wyplosz The Economics of European Integration

© Baldwin&Wyplosz The Economics of European Integration State aid (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”. Turn first to the economics of subsidies and EU’s policy © Baldwin&Wyplosz The Economics of European Integration

Economics: restructuring prevention Consider subsidies that prevent restructuring Specifically, each governments make annual payments to all firms exactly equal to their losses i.e. all 2n’ firms in Figure 6-9 analysis break even, but not new firms Economy stays at point A This changes who pays for the inefficiently small firms from consumers to taxpayers. Mark-up BE BEFT E’ 1 m' E” mA A COMP n’ n” 2n’ Number of firms © Baldwin&Wyplosz The Economics of European Integration

Only some subsidise: unfair competition If Foreign pays ‘break even’ subsidies to its firms All restructuring forced on Home 2n’ moves to n”, but all the exit is by Home firms Unfair Undermines political support for liberalisation © Baldwin&Wyplosz The Economics of European Integration

EU policies on ‘State Aids’ 1957 Treaty of Rome bans state aid that provides firms with an unfair advantage and thus distorts competition. EU founders considered this so important that they empowered the Commission with enforcement. © Baldwin&Wyplosz The Economics of European Integration

Anti-competitive behaviour 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 © Baldwin&Wyplosz The Economics of European Integration

© Baldwin&Wyplosz The Economics of European Integration EU Competition Policy To prevent anti-competitive behavior, EU policy focuses on two main axes: Antitrust and cartels. The Commission tries: to eliminate behaviours that restrict competition (e.g. price-fixing arrangements and cartels) to eliminate abusive behaviour by firms that have a dominant position Merger control. The Commission seeks: to block mergers that would create firms that would dominate the market. © Baldwin&Wyplosz The Economics of European Integration