1. Chapter 6: Market Size and Scale Effects
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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’
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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%).
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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.
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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.
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6. 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
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7. Economic logic: background
Monopoly case
Demand
Curve
Price
Price
Marginal Revenue
Curve
Marginal
Cost Curve
Demand
Curve P’ P* A P” B D
Marginal
Cost C E Q’ Q*
Q’+1
Sales
Sales
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8. Economic logic: background
Duopoly case, example of non-equilibrium
price
price
Firm 1’s expectation of sales by firm 2, Q2
Firm 2’s expectation of sales by firm 1, Q1
p1’
Demand
Curve (D)
Demand
Curve (D)
p2’
Residual Demand
Curve firm 1 (RD1)
Residual Demand
Curve firm 2 (RD2) A1 MC A2 MC
x1’
Firm 1 sales
x2’
Firm 2 sales
Residual Marginal Revenue
Curve firm 1 (RMR1)
Residual Marginal Revenue
Curve firm 2 (RMR2)
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9. 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 MC A MC
RMR
RMR’
sales x*
2x*
x**
sales
3x**
Duopoly
Oligopoly
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BE-COMP diagram
Mark-up (m)
COMP
curve
BE (break-even) curve m’ n’
mmono
mduo
n=1
n=2
Number of firms
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Details of COMP curve
Mark-up
price p'
mmono A’
p"
mduo B’ D
Monopoly
mark-up
Duopoly
mark-up
COMP
curve
R-D (duopoly)
Marginal cost
curve MC B A
Number of firms
n=1
n=2
R-MR
MR (monopoly)
Typical firm’s
sales
xduo
xmono
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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
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13. 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
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14. 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
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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
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”
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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
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17. 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
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18. restructuring prevention: size of subsidy
Pre-integration: fixed costs = operating profit = area “a+b”
Post-integration: operating profit = b+c
ERGO: Breakeven subsidy = a-c
NB: b+c+a-c=a+b
euros
Price
Mark-up
COMP
Demand curve
BEFT E’ E’ p’ a AC A A pA pA A b c MC
2n’
Number of firms
Sales
per firm
Total
sales x’ C’ CA
xA= 2CA/2n’
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19. restructuring prevention: welfare impact
Change producer surplus = zero (profit is zero pre & post)
Change consumer surplus = a+d
Subsidy cost = a-c
Total impact = d+c
euros
Price
Mark-up
COMP
Demand curve
BEFT E’ E’ p’ a AC d A A pA pA A b c MC
2n’
Number of firms
Sales
per firm
Total
sales x’ C’ CA
xA= 2CA/2n’
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20. 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
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21. 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.
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22. 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
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Economic effects
collusion will not in the end raise firm’s profits to above-normal levels.
2n’ is too high for all firms to break even.
Industrial consolidation proceeds as usual, but only to nB. Point B Zero profits earned by all.
prices higher, pB> p”, smaller firms, higher average cost
Mark-up
BEFT
mmono
Perfect
collusion A B pB E”
Partial
collusion p”
COMP
n=1 n” nB
2n’
Number of firms
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Economic effects
The welfare cost of collusion (versus no collusion)
four-sided area marked by pB, p”, E” and B.
price
Demand curve
Mark-up
BEFT
pmono
mmono
Perfect
collusion A B B pB E”
Partial
collusion E” p”
COMP
n=1 n” nB
Number of firms
Total
sales CB
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25. © 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.
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