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Transcript of Theorie und Politik der Europäischen Integration Prof. Dr. Herbert Brücker Lecture 6 Market Size...
Theorie und Politik der Europäischen Integration
Prof. Dr. Herbert Brücker
Lecture 6
Market Size and Scale Effects
Theory and Politics of European Integration
Theory and Politics of European Integration Lecture 5 Preferential Trade Liberalisation
Prof. Dr. Herbert BrückerLehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer ArbeitsmärkteUniversität Bamberg | [email protected] | www.uni-bamberg.de/sowi/bruecker
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
Theory and Politics of European Integration Lecture 5 Preferential Trade Liberalisation
Prof. Dr. Herbert BrückerLehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer ArbeitsmärkteUniversität Bamberg | [email protected] | www.uni-bamberg.de/sowi/bruecker
Today's Lecture - Overview
• Market Size and Scale Effects
Theory and Politics of European Integration Lecture 5 Preferential Trade Liberalisation
Prof. Dr. Herbert BrückerLehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer ArbeitsmärkteUniversität Bamberg | [email protected] | www.uni-bamberg.de/sowi/bruecker
Today's Reading
• Market Size and Scale Effects· Baldwin & Wyplosz (2006) “The Economics of European
Integration”, McGraw-Hill, Ch 6.
Theory and Politics of European Integration Lecture 5 Preferential Trade Liberalisation
Prof. Dr. Herbert BrückerLehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer ArbeitsmärkteUniversität Bamberg | [email protected] | www.uni-bamberg.de/sowi/bruecker
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.’
Theory and Politics of European Integration Lecture 5 Preferential Trade Liberalisation
Prof. Dr. Herbert BrückerLehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer ArbeitsmärkteUniversität Bamberg | [email protected] | www.uni-bamberg.de/sowi/bruecker
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%).
Theory and Politics of European Integration Lecture 5 Preferential Trade Liberalisation
Prof. Dr. Herbert BrückerLehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer ArbeitsmärkteUniversität Bamberg | [email protected] | www.uni-bamberg.de/sowi/bruecker
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.
Theory and Politics of European Integration Lecture 5 Preferential Trade Liberalisation
Prof. Dr. Herbert BrückerLehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer ArbeitsmärkteUniversität Bamberg | [email protected] | www.uni-bamberg.de/sowi/bruecker
Facts
M&A activity by nation, 1991-2002
B, 2.8%
DK, 2.6%
EL, 1.1%
E, 5.0%F, 13.5%
IRL, 1.7%
I, 6.2%
L, 0.5%NL, 6.5%
A, 2.1%
P, 1.2%
FIN, 3.9%
S, 5.3%
UK, 31.4%
D, 16.3%
Theory and Politics of European Integration Lecture 5 Preferential Trade Liberalisation
Prof. Dr. Herbert BrückerLehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer ArbeitsmärkteUniversität Bamberg | [email protected] | www.uni-bamberg.de/sowi/bruecker
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.
Theory and Politics of European Integration Lecture 5 Preferential Trade Liberalisation
Prof. Dr. Herbert BrückerLehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer ArbeitsmärkteUniversität Bamberg | [email protected] | www.uni-bamberg.de/sowi/bruecker
• 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
New Trade Theory: A History of IdeasNew Trade Theory: A History of Ideas (I/V)
Theory and Politics of European Integration Lecture 5 Preferential Trade Liberalisation
Prof. Dr. Herbert BrückerLehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer ArbeitsmärkteUniversität Bamberg | [email protected] | www.uni-bamberg.de/sowi/bruecker
• 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
New Trade Theory: A History of IdeasNew Trade Theory: A History of Ideas (II/V)
Theory and Politics of European Integration Lecture 5 Preferential Trade Liberalisation
Prof. Dr. Herbert BrückerLehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer ArbeitsmärkteUniversität Bamberg | [email protected] | www.uni-bamberg.de/sowi/bruecker
• 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.
New Trade Theory: A History of IdeasNew Trade Theory: A History of Ideas (III/V)
Theory and Politics of European Integration Lecture 5 Preferential Trade Liberalisation
Prof. Dr. Herbert BrückerLehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer ArbeitsmärkteUniversität Bamberg | [email protected] | www.uni-bamberg.de/sowi/bruecker
• 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!
New Trade Theory: A History of IdeasNew Trade Theory: A History of Ideas (IV/V)
Theory and Politics of European Integration Lecture 5 Preferential Trade Liberalisation
Prof. Dr. Herbert BrückerLehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer ArbeitsmärkteUniversität Bamberg | [email protected] | www.uni-bamberg.de/sowi/bruecker
New Trade Theory: A History of IdeasNew Trade Theory: A History of Ideas (V/V)
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.
Theory and Politics of European Integration Lecture 5 Preferential Trade Liberalisation
Prof. Dr. Herbert BrückerLehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer ArbeitsmärkteUniversität Bamberg | [email protected] | www.uni-bamberg.de/sowi/bruecker
New Trade Theory: A History of IdeasNew Trade theory: 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
Theory and Politics of European Integration Lecture 5 Preferential Trade Liberalisation
Prof. Dr. Herbert BrückerLehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer ArbeitsmärkteUniversität Bamberg | [email protected] | www.uni-bamberg.de/sowi/bruecker
New Trade Theory: A History of IdeasFirst key element: Increasing returns 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 contri-bution to total production is small
• Internal and external returns to scale have different consequences, therefore different models. Here: internal returns to scale.
Theory and Politics of European Integration Lecture 5 Preferential Trade Liberalisation
Prof. Dr. Herbert BrückerLehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer ArbeitsmärkteUniversität Bamberg | [email protected] | www.uni-bamberg.de/sowi/bruecker
New Trade Theory: A History of IdeasSecond key element: imperfect competition
• 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.
Theory and Politics of European Integration Lecture 5 Preferential Trade Liberalisation
Prof. Dr. Herbert BrückerLehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer ArbeitsmärkteUniversität Bamberg | [email protected] | www.uni-bamberg.de/sowi/bruecker
New Trade Theory: A History of IdeasSimple Imperfect Competition Theory
• 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.
Theory and Politics of European Integration Lecture 5 Preferential Trade Liberalisation
Prof. Dr. Herbert BrückerLehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer ArbeitsmärkteUniversität Bamberg | [email protected] | www.uni-bamberg.de/sowi/bruecker
Economic logic: Monopoly case (closed economy)
Sales
Price
MarginalCost
Marginal RevenueCurve
DemandCurve
Sales
Price
Q’+1
P”
MarginalCost Curve
C E
D
DemandCurve
A
B
Q*Q’
P*
P’
Theory and Politics of European Integration Lecture 5 Preferential Trade Liberalisation
Prof. Dr. Herbert BrückerLehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer ArbeitsmärkteUniversität Bamberg | [email protected] | www.uni-bamberg.de/sowi/bruecker
Economic logic: Monopoly case (closed economy)
Sales
Price
MarginalCost
Marginal RevenueCurve
DemandCurve
Sales
Price
Q’+1
P”
MarginalCost Curve
C E
D
DemandCurve
A
B
Q*Q’
P*
P’What is the marginal revenue
curve?
price for first unit – Q times change in price
Theory and Politics of European Integration Lecture 5 Preferential Trade Liberalisation
Prof. Dr. Herbert BrückerLehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer ArbeitsmärkteUniversität Bamberg | [email protected] | www.uni-bamberg.de/sowi/bruecker
Economic logic: Monopoly case (closed economy)
Sales
Price
MarginalCost
Marginal RevenueCurve
DemandCurve
Sales
Price
Q’+1
P”
MarginalCost Curve
C E
D
DemandCurve
A
B
Q*Q’
P*
P’
Marginal revenue curve is always below average cost curve!
Theory and Politics of European Integration Lecture 5 Preferential Trade Liberalisation
Prof. Dr. Herbert BrückerLehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer ArbeitsmärkteUniversität Bamberg | [email protected] | www.uni-bamberg.de/sowi/bruecker
MC
AC
Output, q
Price, p
Demand
Marginal Revenue (MC)
pMC
qMC
Economic logic: Monopoly case (closed economy)
Theory and Politics of European Integration Lecture 5 Preferential Trade Liberalisation
Prof. Dr. Herbert BrückerLehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer ArbeitsmärkteUniversität Bamberg | [email protected] | www.uni-bamberg.de/sowi/bruecker
New Trade Theory: A History of IdeasMonopolistic Competition
• 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
Theory and Politics of European Integration Lecture 5 Preferential Trade Liberalisation
Prof. Dr. Herbert BrückerLehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer ArbeitsmärkteUniversität Bamberg | [email protected] | www.uni-bamberg.de/sowi/bruecker
• Profit-maximizing firms fix prices and production under monopolistic competition such that marginal revenues equal marginal costs, i.e. at point Q*.
• Note that marginal revenues depend on residual demand curve (RD).
• Differences between marginal costs and price is called as markup.
Sales
Price
MCMR
RD
RD’
MR’
Q’
P’
Q*
P*
The Residual Demand-Marginal Revenue Diagram
Theory and Politics of European Integration Lecture 5 Preferential Trade Liberalisation
Prof. Dr. Herbert BrückerLehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer ArbeitsmärkteUniversität Bamberg | [email protected] | www.uni-bamberg.de/sowi/bruecker
New Trade Theory: A History of IdeasWhat happens at market entry of new firms?
• 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.
Theory and Politics of European Integration Lecture 5 Preferential Trade Liberalisation
Prof. Dr. Herbert BrückerLehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer ArbeitsmärkteUniversität Bamberg | [email protected] | www.uni-bamberg.de/sowi/bruecker
Duopoly case, example of non-equilibrium
Residual Demand Curve firm 2 (RD2)
Firm 2’s expectation of sales by firm 1, Q1
DemandCurve (D)
MC
Residual Marginal Revenue Curve firm 2 (RMR2)
x2’
p2’
Firm 2 sales
Residual Demand Curve firm 1 (RD1)
Firm 1’s expectation of sales by firm 2, Q2
DemandCurve (D)
price
MC
Residual Marginal Revenue Curve firm 1 (RMR1)
x1’
p1’
Firm 1 sales
A1 A2
price
Theory and Politics of European Integration Lecture 5 Preferential Trade Liberalisation
Prof. Dr. Herbert BrückerLehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer ArbeitsmärkteUniversität Bamberg | [email protected] | www.uni-bamberg.de/sowi/bruecker
Duopoly and oligopoly case, equilibrium 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
Theory and Politics of European Integration Lecture 5 Preferential Trade Liberalisation
Prof. Dr. Herbert BrückerLehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer ArbeitsmärkteUniversität Bamberg | [email protected] | www.uni-bamberg.de/sowi/bruecker
• 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.
The PP-CC or the BE-COMP Diagram
Theory and Politics of European Integration Lecture 5 Preferential Trade Liberalisation
Prof. Dr. Herbert BrückerLehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer ArbeitsmärkteUniversität Bamberg | [email protected] | www.uni-bamberg.de/sowi/bruecker
BE
COMP
Krugman’s CC-PP Diagram
Theory and Politics of European Integration Lecture 5 Preferential Trade Liberalisation
Prof. Dr. Herbert BrückerLehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer ArbeitsmärkteUniversität Bamberg | [email protected] | www.uni-bamberg.de/sowi/bruecker
Breakeven-Competition (BE-COMP) Diagram
Mark-up ()
COMPcurve
BE (break-even) curve
’
n’
mono
duo
n=1 n=2 Number of firms
Theory and Politics of European Integration Lecture 5 Preferential Trade Liberalisation
Prof. Dr. Herbert BrückerLehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer ArbeitsmärkteUniversität Bamberg | [email protected] | www.uni-bamberg.de/sowi/bruecker
• 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 profit-maximizing prices and just breakeven, i.e. price equals average costs (P=AC)
Determination of equilibrium number of firms
Theory and Politics of European Integration Lecture 5 Preferential Trade Liberalisation
Prof. Dr. Herbert BrückerLehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer ArbeitsmärkteUniversität Bamberg | [email protected] | www.uni-bamberg.de/sowi/bruecker
Details of COMP curve
Marginal cost curve
Typical firm’s sales
price
p"
Monopoly mark-up
Duopoly mark-up
D
R-D (duopoly)
xmonoxduo
MR (monopoly)R-MR
MC
p'
AB
A’
B’
COMPcurve
n=1 n=2
mono
duo
Theory and Politics of European Integration Lecture 5 Preferential Trade Liberalisation
Prof. Dr. Herbert BrückerLehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer ArbeitsmärkteUniversität Bamberg | [email protected] | www.uni-bamberg.de/sowi/bruecker
Details of BE curve
Sales per firm
AC
price
Totalsales
Co
Demand curve
Mark-up (i.e., p-MC)
o
xo= Co/no
MC
euros
BE
no
poo+MC
x’= Co/n’ x”= Co/n”
A
B
B Apo
ACo=po
n” n’
Home market
Theory and Politics of European Integration Lecture 5 Preferential Trade Liberalisation
Prof. Dr. Herbert BrückerLehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer ArbeitsmärkteUniversität Bamberg | [email protected] | www.uni-bamberg.de/sowi/bruecker
• 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 pro-competitive effects
Implications of monopolistic competition for trade (Krugman’s model)
Theory and Politics of European Integration Lecture 5 Preferential Trade Liberalisation
Prof. Dr. Herbert BrückerLehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer ArbeitsmärkteUniversität Bamberg | [email protected] | www.uni-bamberg.de/sowi/bruecker
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.
Theory and Politics of European Integration Lecture 5 Preferential Trade Liberalisation
Prof. Dr. Herbert BrückerLehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer ArbeitsmärkteUniversität Bamberg | [email protected] | www.uni-bamberg.de/sowi/bruecker
Recall: autarky equilibrium
Sales per firm
AC
price
Totalsales
Demand curve
Mark-upeuros
x’
BE
n’
E’
C’
E’
MC
p’ '
A
p’
Home market
E’
C
Theory and Politics of European Integration Lecture 5 Preferential Trade Liberalisation
Prof. Dr. Herbert BrückerLehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer ArbeitsmärkteUniversität Bamberg | [email protected] | www.uni-bamberg.de/sowi/bruecker
No-trade-to-free-trade integration
Sales per firm
AC
price
Totalsales
Demand curve
Mark-upeuros
x’
BE
2n’
x”
n” n’
E’
E”
C’ C”
E’
A
1
E”
A
MC
p”
p’
pA
'
A
p”
p’
Home market
E”
E’
C
Theory and Politics of European Integration Lecture 5 Preferential Trade Liberalisation
Prof. Dr. Herbert BrückerLehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer ArbeitsmärkteUniversität Bamberg | [email protected] | www.uni-bamberg.de/sowi/bruecker
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.
Theory and Politics of European Integration Lecture 5 Preferential Trade Liberalisation
Prof. Dr. Herbert BrückerLehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer ArbeitsmärkteUniversität Bamberg | [email protected] | www.uni-bamberg.de/sowi/bruecker
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”.
Theory and Politics of European Integration Lecture 5 Preferential Trade Liberalisation
Prof. Dr. Herbert BrückerLehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer ArbeitsmärkteUniversität Bamberg | [email protected] | www.uni-bamberg.de/sowi/bruecker
• 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).
AC
euros
x’
p’E’
MC
x”
p”
Firm-level output
Why do prices fall under zero profit condition?
E”
Theory and Politics of European Integration Lecture 5 Preferential Trade Liberalisation
Prof. Dr. Herbert BrückerLehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer ArbeitsmärkteUniversität Bamberg | [email protected] | www.uni-bamberg.de/sowi/bruecker
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.
Theory and Politics of European Integration Lecture 5 Preferential Trade Liberalisation
Prof. Dr. Herbert BrückerLehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer ArbeitsmärkteUniversität Bamberg | [email protected] | www.uni-bamberg.de/sowi/bruecker
NEXT LECTURE
• November 27