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 Preferential Trade Liberalisation The PTA Diagram
Theory and Politics of European Integration Lecture 4 Market Size and Scale Effects
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

3. An example Pre-PTA case (MFN tariff) Country A, B + C produce cars
Theory and Politics of European Integration Lecture 4 Market Size and Scale Effects
An example
Pre-PTA case (MFN tariff)
Country A, B + C produce cars
Country B + C export cars to A
Country A imposes a tariff of 10% in imports of cars
Prices: In country B+C the price for a car is 20,000 Euro, in country A 20, ,000 = 22,000 Euros
The border price (price before tariffs) in country A is 20,000 Euros (equal to price exporters from A+B receive)
The profits of the maximum-cost producer in A, B and C are zero, but the other producers realize positive profits (producer’s rents)
The marginal utility of the last consumer of cars in A+B+C is zero, but the average consumer realises positive rents (consumer rents)

4. RoW Partner Home XSR XSP P’ P MD Uniform MFN Tariff P’ P P’-T XR’ XR
Theory and Politics of European Integration Lecture 4 Market Size and Scale Effects
Uniform MFN Tariff
RoW
Border
price
Border
price
Partner
Domestic price
Home
MSMFN
XSR
XSP MS P’ P’ P P T
P’-T Pa T MD p*
RoW
Exports
Partner
Exports
Home
imports
XR’ XR
XP’ XP M’
MFREE

5. An example The PTA case: prices
Theory and Politics of European Integration Lecture 4 Market Size and Scale Effects
An example
The PTA case: prices
A removes the tariff on cars for B, but maintains it for C
The border price for country B equals the domestic price in A, but there is still a difference between the domestic and the border price of 10% for C
Since the marginal producer in B can produce at lower costs than A prices fall in A depending on marginal demand
Let’s assume prices fall in A by 5%. This implies that the border price for B’s exporters increase by 5%. This in turn implies that the domestic price in B for cars increase by 5% as well.
The new price in the PTA is thus 21,000 Euros.
The border price for exporters from C is consequently ~19,090 Euros.

6. Domestic Price and Border Price Changes
Theory and Politics of European Integration Lecture 4 Market Size and Scale Effects
Domestic Price and Border Price Changes
Border price
Border price
Domestic price
MSMFN
XSR
XSP
MSPTA MS P’ P” P” T
P’-T
P’-T
P”-T
domestic price falls to P’’ from P’, e.g. from 22,000 to 21,000 MD
XR”
XR’
RoW
Exports
XP’
XP”
Partner
Exports M’ M”
Home
imports

7. Domestic Price and Border Price Changes
Theory and Politics of European Integration Lecture 4 Market Size and Scale Effects
Domestic Price and Border Price Changes
Border price
Border price
Domestic price
MSMFN
XSR
XSP
MSPTA MS P’ P” P” T
P’-T
P’-T
P”-T
domestic price falls to P’ from P”, e.g. from 22,000 to 21,000
Partner-based firms
see border price rise,
from P’-T to P”, e.g. from 20,000 to 21,000 € MD
XR”
XR’
RoW
Exports
XP’
XP”
Partner
Exports M’ M”
Home
imports

8. Domestic Price and Border Price Changes
Theory and Politics of European Integration Lecture 4 Market Size and Scale Effects
Domestic Price and Border Price Changes
Border price
RoW firms see
border price
fall from
P’-T to P”-T, e.g. from 20,000 to ~19,090
Border price
Domestic price
MSMFN
XSR
XSP
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’
RoW
Exports
XP’
XP”
Partner
Exports M’ M”
Home
imports

9. An example The PTA case: quantities I
Theory and Politics of European Integration Lecture 4 Market Size and Scale Effects
An example
The PTA case: quantities I
At the lower prices consumer’s in A consume more. Let’s assume consumption increases from 20,000 to 21,000 (+1,000) there.
Since the price has fallen in A, producers produce less there. Let’s say 17,500 instead of 18,000 (-500)
Since prices have increased in partner country B, consumers consume less cars there. Let’s say 18,000 instead of 19,000 (-1,000).
Since prices have increased in B, producers in B produce more. Let’s say 21,000 instead of 20,000 (+1,000).
Thus, B exports 3,000 instead of 1,000 cars (+2,000) to A now.

10. An example The PTA case: quantities
Theory and Politics of European Integration Lecture 4 Market Size and Scale Effects
An example
The PTA case: quantities
Since the border price for C’s exporters has fallen, they export less cars to A. Let’s say 500 instead of 1,000 (-500).
Thus, A imports 3,500 instead of 2,000 cars now.
2,500 from B and 500 from C.
The import increase by 1,500 cars is sometimes called “trade creation”.
The replacement of exports from C by imports from B (500) is sometimes called “trade diversion” or better “supply-switching”.
Note that this implies switching from suppliers with lower marginal costs in C to a supplier with higher marginal costs in B.

11. Quantity Changes: Supply Switching
Theory and Politics of European Integration Lecture 4 Market Size and Scale Effects
Quantity Changes: Supply Switching
Domestic price
Home
imports MD
RoW
Exports
Partner
XSP
XSR MS
MSMFN M’
Border price
MSPTA P’ T P”
P’-T
P”-T
XR”
XR’
XP’
XP” M”

12. Quantity Changes: Supply Switching
Theory and Politics of European Integration Lecture 4 Market Size and Scale Effects
Quantity Changes: Supply Switching
Domestic price
Home
imports MD
RoW
Exports
Partner
XSP
XSR MS
MSMFN M’
Border price
MSPTA P’ T P”
P’-T
P”-T
XR”
XR’
XP’
XP” M”
RoW exports fall, e.g. by 500 cars.
Partner exports increase, e.g. by 3,000 cars.
Home imports increase, e.g. by 2,500 cars.

13. An example The PTA case: welfare (country A)
Theory and Politics of European Integration Lecture 4 Market Size and Scale Effects
An example
The PTA case: welfare (country A)
Consumers benefit from lower prices (times the quantity of consumption before the PTA) plus from higher marginal utility from further consumption.
Producers lose from lower prices (times the new production level) and in addition from lower production
However, the consumer gains are larger than the producer losses.
But: The government loses tariff revenues.
Note: By importing more from B, A has switched from the marginal supplier in C (20,000 Euros before the PTA) to a higher-cost supplier in B (21,000 Euros) (supply-switch or trade diversion).

14. Today's Lecture - Overview
Theory and Politics of European Integration Lecture 4 Market Size and Scale Effects
Today's Lecture - Overview
Market Size and Scale Effects
EU Competition Policies
EU Trade Policies

15. Today's Reading Market Size and Scale Effects
Theory and Politics of European Integration Lecture 4 Market Size and Scale Effects
Today's Reading
Market Size and Scale Effects
Baldwin & Wyplosz (2009) “The Economics of European Integration”, McGraw-Hill, Ch 6.
Competition and State Aid Policies
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.

16. Facts: integration associated with mergers, acquisitions, etc.
Theory and Politics of European Integration Lecture 4 Market Size and Scale Effects
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.’

17. Sketch of economic logic
Theory and Politics of European Integration Lecture 4 Market Size and Scale Effects
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.

18. Sketch of economic logic
Theory and Politics of European Integration Lecture 4 Market Size and Scale Effects
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.

19. Monopolies and duopolies
Theory and Politics of European Integration Lecture 4 Market Size and Scale Effects
Monopolies and duopolies
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

20. Economic logic (background): Monopoly case
Theory and Politics of European Integration Lecture 4 Market Size and Scale Effects
Economic logic (background): Monopoly case
Demand
Curve
Price
Price
Marginal Revenue
Curve
Marginal
Cost Curve P*
Demand
Curve P’ A P” B D
Marginal
Cost C E Q’
Q’+1 Q*
Sales
Sales

21. Economic logic (background): Monopoly case
Theory and Politics of European Integration Lecture 4 Market Size and Scale Effects
Economic logic (background): Monopoly case
Demand
Curve
Price
Price
Marginal Revenue
Curve
Marginal
Cost Curve P*
Demand
Curve P’ A P”
Extra revenues of one unit: D + E – A.
„marginal revenue“ B D
Marginal
Cost C E Q’
Q’+1 Q*
Sales
Sales

22. Economic logic (background): Monopoly case
Theory and Politics of European Integration Lecture 4 Market Size and Scale Effects
Economic logic (background): Monopoly case
Demand
Curve
Price
Price
Marginal Revenue
Curve
Marginal
Cost Curve P*
Demand
Curve P’ A
Profitmaximum: marginal revenue equals marginal costs. P” B D
Marginal
Cost C E Q’
Q’+1 Q*
Sales
Sales

23. Duopoly case, example of non-equilbrium
Theory and Politics of European Integration Lecture 4 Market Size and Scale Effects
Duopoly case, example of non-equilbrium
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)

24. Duopoly and oligopoly case, equilbrium outcome
Theory and Politics of European Integration Lecture 4 Market Size and Scale Effects
Duopoly and oligopoly case, equilbrium 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

25. Presentation of theory here in Breakeven-Competition (BE-COMP)-Diagram
Theory and Politics of European Integration Lecture 4 Market Size and Scale Effects
Bringing this to trade
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

26. Breakeven-Competion (BE-COMP) Diagram
Theory and Politics of European Integration Lecture 4 Market Size and Scale Effects
Breakeven-Competion (BE-COMP) Diagram
Mark-up (m)
COMP
curve
BE (break-even) curve m’ n’
mmono
mduo
n=1
n=2
Number of firms

27. Breakeven-Competion (BE-COMP) Diagram
Theory and Politics of European Integration Lecture 4 Market Size and Scale Effects
Breakeven-Competion (BE-COMP) Diagram
Mark-up (µ): Price mark-up over costs,
depends on competition.Thus, BE curve slopes downward.
Mark-up (m)
COMP
curve
BE (break-even) curve m’ n’
mmono
mduo
n=1
n=2
Number of firms

28. Breakeven-Competion (BE-COMP) Diagram
Theory and Politics of European Integration Lecture 4 Market Size and Scale Effects
Breakeven-Competion (BE-COMP) Diagram
Mark-up (m)
COMP
curve
BE (break-even) curve m’ n’
mmono
mduo
n=1
n=2
Number of firms
Breakeven (BE) curve: With increasing returns to scale only a limited number of firms can survive. Survival depends on markup µ.
Slopes upward. Why?

29. Details of COMP curve p' mmono p" mduo D R-D (duopoly) Marginal cost
Theory and Politics of European Integration Lecture 4 Market Size and Scale Effects
Details of COMP curve
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
n=1
n=2
R-MR
MR (monopoly)
Typical firm’s sales
xduo
xmono

30. Details of BE curve: closed economy
Theory and Politics of European Integration Lecture 4 Market Size and Scale Effects
Details of BE curve: closed economy
Mark-up
(i.e., p-MC)
euros
price
Home market
po=mo+MC
Demand curve BE A
ACo=po B A po mo B
COMP AC MC n” no n’
Sales
per firm Co
Total
sales
x”= Co/n”
x’= Co/n’
xo= Co/no

31. Outline of BE-COMP Diagram
Theory and Politics of European Integration Lecture 4 Market Size and Scale Effects
Outline of BE-COMP Diagram
euros
price
Mark-up
Home market
COMP curve
Average cost curve
Demand curve
Demand curve BE E’ E’ E’ 1 p’ p’ m' C E” E” E” p” p” A mA A pA AC MC n’ n”
2n’ x’ x”
Sales
per firm C’ C”
Total
sales

32. Outline of BE-COMP Diagram
Theory and Politics of European Integration Lecture 4 Market Size and Scale Effects
Outline of BE-COMP Diagram
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’ E’ E’ 1 p’ p’ m' C E” E” E” p” p” A mA A pA AC MC n’ n”
2n’ x’ x”
Sales
per firm C’ C”
Total
sales

33. Outline of BE-COMP Diagram
Theory and Politics of European Integration Lecture 4 Market Size and Scale Effects
Outline of BE-COMP Diagram
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’ E’ E’ 1 p’ p’ m' C E” E” E” p” p” A pA mA A AC MC n’ n”
2n’ x’ x”
Sales
per firm C’ C”
Total
sales

34. Outline of BE-COMP Diagram
Theory and Politics of European Integration Lecture 4 Market Size and Scale Effects
Outline of BE-COMP Diagram
euros
price
Mark-up
Home market
COMP curve
Average cost curve
Demand curve
Demand curve
Breakeven curve is upward shifting, since sales per firm fall with increasing firm number such that higher mark-up is needed to breakeven BE
Average cost of representative firm equals price after adjustment of firm number E’ E’ E’ 1 p’ p’ m' C E” E” E” p” p” A pA mA A AC MC n’ n”
2n’ x’ x”
Sales
per firm C’ C”
Total
sales

35. Addressing European integration
Theory and Politics of European Integration Lecture 4 Market Size and Scale Effects
Addressing European integration
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 mark-up, equilibrium number of firms, average costs, price and demand?

36. No-trade-to-free-trade integration
Theory and Politics of European Integration Lecture 4 Market Size and Scale Effects
No-trade-to-free-trade integration
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’ E’ E’ 1 p’ p’ m' C E” E” E” p” p” A A pA mA AC MC n’ n”
2n’ x’ x”
Sales
per firm C’ C”
Total
sales

37. No-trade-to-free-trade integration
Theory and Politics of European Integration Lecture 4 Market Size and Scale Effects
No-trade-to-free-trade integration
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’ E’ E’ 1 p’ p’ m' C E” E” E” p” p” A A pA mA AC MC n’ n”
2n’ x’ x”
Sales
per firm C’ C”
Total
sales

38. No-trade-to-free-trade integration
Theory and Politics of European Integration Lecture 4 Market Size and Scale Effects
No-trade-to-free-trade integration
euros
price
Mark-up
Home market
Market size effect: BE curve shifts outward to the right. At given number of firms (point 1) we have no equilibrium).
Average cost curve
Demand curve BE E’ E’ E’ 1 p’ p’ m' C E” E” E” p” p” A A pA mA AC MC n’ n”
2n’ x’ x”
Sales
per firm C’ C”
Total
sales

39. No-trade-to-free-trade integration
Theory and Politics of European Integration Lecture 4 Market Size and Scale Effects
No-trade-to-free-trade integration
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’ E’ E’ 1 p’ p’ m' C E” E” E” p” p” A A pA mA AC MC n’ n”
2n’ x’ x”
Sales
per firm C’ C”
Total
sales

40. No-trade-to-free-trade integration
Theory and Politics of European Integration Lecture 4 Market Size and Scale Effects
No-trade-to-free-trade integration
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’ E’ E’ 1 p’ p’ m' C E” E” E” p” p” A A pA mA AC MC n’ n”
2n’ x’ x”
Sales
per firm C’ C”
Total
sales

41. No-trade-to-free-trade integration
Theory and Politics of European Integration Lecture 4 Market Size and Scale Effects
No-trade-to-free-trade integration
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’ E’ E’ 1 p’ p’ m' C E” E” E” p” p” A A pA mA AC MC n’ n”
2n’ x’ x”
Sales
per firm C’ C”
Total
sales

42. Pro-competitive effect:
Theory and Politics of European Integration Lecture 4 Market Size and Scale Effects
Economic logic
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: ,
Can’t see in diagram.
Pro-competitive effect:
Equilibrium moves from E’ to A: Firms losing money (below BE).
Pro-competitive effect = mark-up falls.
short-run price impact p’ to pA.

43. Industrial Restructuring:
Theory and Politics of European Integration Lecture 4 Market Size and Scale Effects
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”.

44. M&A activity is high in EU.
Theory and Politics of European Integration Lecture 4 Market Size and Scale Effects
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%).
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

45. Distribution of M&A quite varied:
Theory and Politics of European Integration Lecture 4 Market Size and Scale Effects
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 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

46. Theory and Politics of European Integration
Theory and Politics of European Integration Lecture 4 Market Size and Scale Effects
Facts

47. Why M&A mostly within EU? Why UK’s share so large?
Theory and Politics of European Integration Lecture 4 Market Size and Scale Effects
Facts
Why M&A mostly within EU?
Why UK’s share so large?
Non-harmonised takeovers rules.
some members have very restrictive take-over practices, makes M&As very difficult.
others, UK, very liberal rules.
Lack of harmonisation means restructuring effects vary impact by member states.

48. EU Competition and State Aid Policy
Theory and Politics of European Integration Lecture 4 Competition and Trade Policy
EU Competition and State Aid Policy

49. Competition and subsidies
Theory and Politics of European Integration Lecture 4 Competition and Trade Policy
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 14, 3rd Edition.

50. Exclusive competency of EU; Commission controls.
Theory and Politics of European Integration Lecture 4 Competition and Trade Policy
EU Competition Policy
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

51. Anti-competitive behaviour
Theory and Politics of European Integration Lecture 4 Competition and Trade Policy
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

52. Economic effects Consider two cases: Perfect collusion:
Theory and Politics of European Integration Lecture 4 Competition and Trade Policy
Economic effects
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
n=1 n” nB
2n’
nP’
Number of firms

53. Prices higher, pB> p”, smaller firms, higher average cost.
Theory and Politics of European Integration Lecture 4 Competition and Trade Policy
Economic effects
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
n=1 n” nB
2n’
Number of firms

54. Economic effects (cont.)
Theory and Politics of European Integration Lecture 4 Competition and Trade Policy
Economic effects (cont.)
price
The welfare cost of collusion (versus no collusion)
four-sided area marked by pB, p”, E” and B.
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

55. Antitrust and cartels. The Commission tries:
Theory and Politics of European Integration Lecture 4 Competition and Trade Policy
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.

56. Suppose price without cartel would be P. Cartel raises price to P’.
Theory and Politics of European Integration Lecture 4 Competition and Trade Policy
Economics of cartels
euros
Quantity C’ C P’
P = AC a b
Demand curve
Suppose price without cartel would be P.
Cartel raises price to P’.
Consumers lose: -a-b; ‘rip-off’-effect
Producers gain: a.
Net loss: b.
“technical inefficiency”

57. The vitamin cartels (Box 11‑1)
Theory and Politics of European Integration Lecture 4 Competition and Trade Policy
The vitamin cartels (Box 11‑1)
In 2001, EU Commission fined 8 companies for their participation in cartels that eliminated competition in the vitamin sector (vitamins A, E, B1, B2, B5, B6, C, D3, Biotin, Folic acid, Beta Carotene and carotinoids) for more than ten years.
The European vitamins market is worth almost 1 billion euros a year.
The firms fixed prices, allocated sales quotas, agreed on and implemented price increases and issued price announcements in according to agreed procedures.
EU can fine firms up to 10 % of total annual sales.

58. The vitamin cartels (Box 11‑1) (cont.)
Theory and Politics of European Integration Lecture 4 Competition and Trade Policy
The vitamin cartels (Box 11‑1) (cont.)
They also set up a mechanism to monitor and enforce their agreements and participated in regular meetings to implement their plans. This included the establishment of formal structure and hierarchy of different levels of management, often with overlapping membership at the most senior levels to ensure the functioning of the cartels, the exchange of sales values, volumes of sales and pricing information on a quarterly or monthly basis at regular meetings, and the preparation, agreement and implementation and monitoring of an annual "budget" followed by the adjustment of actual sales achieved so as to comply with the quotas allocated.
Hoffman-La Roche of Switzerland received the largest fine (462m euros) for being the cartel ringleader, which also included BASF and Merck (Germany), Aventis SA (France), Solvay Pharmaceuticals (the Netherlands), Daiichi Pharmaceutical, Esai and Takeda Chemical Industries (Japan).

59. Exclusive territories
Theory and Politics of European Integration Lecture 4 Competition and Trade Policy
Exclusive territories
euros
Quantity
PGermany
PUK
DGermany
DUK MC
MRGermany
MRUK
More common anti-competitive practice is ‘exclusive territories’
Nintendo example; high prices in Germany vs UK.
Prevent arbitrage within the EU (illegal).
European Commission fined Nintendo and the 7 distributors 168 million euros.

60. Exclusive territories
Theory and Politics of European Integration Lecture 4 Competition and Trade Policy
Exclusive territories
euros
Quantity
PGermany
PUK
DGermany
DUK MC
MRGermany
MRUK
German demand curve steeper, i.e. higher willingness to pay (lower price elasticity)
UK has flatter demand curve (e.g. more opportunties to substitute, higher price elasticity)
Profits are maximized where marginal revenue and marginal costs curve intersect
This implies requesting higher price in DE relative to UK

61. Abuse of dominant position
Theory and Politics of European Integration Lecture 4 Competition and Trade Policy
Abuse of dominant position
Firms that are lucky or possess excellent products can establish very strong positions in their market.
Not a problem, per se
position may reflect superior products and/or efficiency
e.g. Google’s triumph
However dominance may tempt firm to extract extra profits from suppliers or customers
Or arrange the market to shield itself from future competitors. E.g. hiding the programm code.
Illegal under EU law ‘abuse of dominant position.’
e.g. Microsoft with media software
charge high price of Word, etc. where the competition has been driven out of biz (WordPerfect, etc.), but give for free all software where there is still competition.

62. Williamson diagram Merger control Initially P=AC.
Theory and Politics of European Integration Lecture 4 Competition and Trade Policy
Merger control
euros
Quantity C’ C P’
P=AC a b c
Demand curve
AC’
Williamson diagram
Initially P=AC.
Merger implies lower AC to AC’, but raises the price to P’.
DCS=-a-b; ‘ripoff’
DPS=+a+c
Net welfare = -b+c ; ambiguous, ‘efficiency defence’
Laissez-faire (in US and increasingly in EU); if free entry then P driven down to AC’ eventually.
Overall gains as in BE-COMP diagram.

63. Restructuring prevention. Unfair competition.
Theory and Politics of European Integration Lecture 4 Competition and Trade Policy
State aid economics
Look at two cases:
Restructuring prevention.
Unfair competition.

64. Restructuring prevention
Theory and Politics of European Integration Lecture 4 Competition and Trade Policy
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

65. Restructuring prevention: size of benefit
Theory and Politics of European Integration Lecture 4 Competition and Trade Policy
Restructuring prevention: size of benefit
Pre-integration: fixed costs = operating profit = area “a+b”
Post-integration: operating profit = b+c
ERGO: Breakeven subsidy = a-c
Net Benefit: 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’

66. Restructuring prevention: welfare impact
Theory and Politics of European Integration Lecture 4 Competition and Trade Policy
Restructuring prevention: welfare impact
Change producer surplus = zero (profit is zero pre & post)
Change consumer surplus = a+d
Subsidy cost = a-c (producer’s loss)
Total impact = a+d – (a-c)= 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’

67. Does it make sense to subsidize?
Theory and Politics of European Integration Lecture 4 Competition and Trade Policy
Does it make sense to subsidize?
Static welfare gains resulting from inefficiency of imperfect competition, i.e. differences between average and marginal costs
Higher production = higher welfare under increasing returns to scale
However, subsidizing loss-making enterprizes creates dynamic losses -> reduced innovation and technological progress

68. Only some subsidise: unfair competition
Theory and Politics of European Integration Lecture 4 Competition and Trade Policy
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

69. EU policies on ‘State Aids’
Theory and Politics of European Integration Lecture 4 Competition and Trade Policy
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.

70. Theory and Politics of European Integration
Theory and Politics of European Integration Lecture 4 Competition and Trade Policy
Theory and Politics of European Integration Lecture 4 Competition and Trade Policy
EU Trade Policies

71. Trade: Facts Two-thirds of EU25 exports are to other EU25 nations.
Theory and Politics of European Integration Lecture 4 Competition and Trade Policy
Trade: Facts
Two-thirds of EU25 exports are to other EU25 nations.
More than 90% of this is actually among the EU15 trade (10 new Member States are fairly small economically).
Add all other European nations, three-fourth of Europe’s trade is within Europe.
North America and Asia are the EU25’s main markets outside Europe, each accounts less than one-tenth of EU exports.
Africa, Latin America and the Middle East are not very important.
The pattern on the import side is very similar
Rounding off, three-fourth of EU imports are from Europe, with the fourth quarter split into two more or less even groups of nations – Asia, and all other nations. Trade with non-European nations is balanced.

72. Facts: Patterns of Trade
Theory and Politics of European Integration Lecture 4 Competition and Trade Policy
Facts: Patterns of Trade

73. Facts: Differences across Member States: non-EU trade
Theory and Politics of European Integration Lecture 4 Competition and Trade Policy
Facts: Differences across Member States: non-EU trade

74. Composition of imports and exports, aggregate trade
Theory and Politics of European Integration Lecture 4 Competition and Trade Policy
Composition of imports and exports, aggregate trade
Manufactured goods 90% of total exports (half of all exports being machinery and transport equipment).
Import side, two-thirds on manufactured goods.
EU-25 is a big importer of fuel (18 % of imports).
Only 6% food and agriculture.
Other types of goods play a relatively minor part in the EU’s trade.

75. Composition of imports and exports, aggregate trade
Theory and Politics of European Integration Lecture 4 Competition and Trade Policy
Composition of imports and exports, aggregate trade

76. EU External Trade Policy: Institutions and trade in goods
Theory and Politics of European Integration Lecture 4 Competition and Trade Policy
EU External Trade Policy: Institutions and trade in goods
Recall: Customs Union requires common trade policy
Trade policy among the ‘first pillar’ since Rome Treaty
European Commission has the right to set tariffs and negotiate on trade issues at WTO
EC Trade Commissioner negotiates, has a mandate assigned by the council of ministers
Council has final say

77. EU Trade Policies: other areas
Theory and Politics of European Integration Lecture 4 Competition and Trade Policy
EU Trade Policies: other areas
World trade negotiations involve far more than trade in goods.
Trade-related intellectual property rights (TRIPs)
Trade-related investment measures (TRIMs),
Service trade
Technical Barriers to Trade (TBTs), trade facilitation, etc.
Treaty of Rome only gave Commission power over trade in goods
Treaty of Nice (& Amsterdam) extended Commission’s authority to some aspects of Services trade and TRIPs, & made QMV the rule in Council on such matters.

78. Contingent protection
Theory and Politics of European Integration Lecture 4 Competition and Trade Policy
Contingent protection
WTO allows members to raise tariffs to:
Counter ‘unfair’ trade practices, e.g.
Antidumping measures, e.g. penalty tariffs
Countervailing duties, e.g. ‘voluntary agreements’ of ‘price-undertakings’
Firms charge higher prices, but EU loses tariff revenue
Provide temporary protection “safeguards”
Widely applied by US and EU
The various WTO articles on these require a procedure; in EU the Commission is in charge of these procedures, but the final decision is subject to QMV approval of the Council.

79. EU External Trade Policy: MFN Tariffs
Theory and Politics of European Integration Lecture 4 Competition and Trade Policy
EU External Trade Policy: MFN Tariffs
MFN tariff structure reflects comparative advantage of EU industries
Low tariffs in manufacturing
Exception: textiles and clothing
High in food and agriculture, especially diary products
Interest groups matter

80. EU’s MFN tariff structure (Common External Tariff – CET)
Theory and Politics of European Integration Lecture 4 Competition and Trade Policy
EU’s MFN tariff structure (Common External Tariff – CET)

81. EU External Trade Policy: Preferential Agreements
Theory and Politics of European Integration Lecture 4 Competition and Trade Policy
EU External Trade Policy: Preferential Agreements
EU has special deals with 139 nations; often more than one per partner.
Each can be very complex ...

82. EU External Trade Policy
Theory and Politics of European Integration Lecture 4 Competition and Trade Policy
EU External Trade Policy

83. Preferential agreements: logic
Theory and Politics of European Integration Lecture 4 Competition and Trade Policy
Preferential agreements: logic
‘Hub’ and ‘Spoke’ System
EU is a regional ‘hub’ in ‘hub’ and ‘spoke’ system of trade deals
Morocco is a typical case: 71% of exports to EU, but only 1% of EU imports from Morocco
Asymmetry gives EU high leverage in dealing with these nations

84. EU External Trade Policy: European circle
Theory and Politics of European Integration Lecture 4 Competition and Trade Policy
EU External Trade Policy: European circle
European-Mediterranean area:
West, Central and Eastern Europe = Single market in industrial goods;
EU + EEA + Swiss bilateral agreements
Euro-Mediterranean Association Agreements:
Morocco, Algeria, Tunisia, Egypt, Israel, the Palestinian Authority, Lebanon, Jordon, Syria and Turkey.
Asymmetric (EU cuts its tariffs faster) FTAs in manufactures, by 2010.
Turkey unilaterally in Customs Union in manufactures.

85. EU External Trade Policy: European circle (cont.)
Theory and Politics of European Integration Lecture 4 Competition and Trade Policy
EU External Trade Policy: European circle (cont.)
European-Mediterranean area (cont.):
Asymmetric dependence (e.g. 70% of Morocco’s exports to EU, but <1% of EU to Morocco)
EFTA’s “FTA union” with EU; EFTAns mimic EU to avoid discrimination against EFTA-based exporters.

86. Former Soviet Republics & Western Balkans
Theory and Politics of European Integration Lecture 4 Competition and Trade Policy
Former Soviet Republics & Western Balkans
Partnership and Cooperation Agreements (PCAs).
These are GSP+ (GSP=Generalised System of Preference).
Russia, Ukraine, Georgia, Belarus, Armenia, Azerbaijan, Kazakhstan, Kyrgyzstan, Moldova and Uzbekistan.
Asymmetric tariff reduction without requiring PCA partners lowering theirs.
Stabilisation and Association Agreements (SAAs).
Former Yugoslavian states.
Croatia has started membership; others likely to follow.

87. Preferential arrangements with former colonies
Theory and Politics of European Integration Lecture 4 Competition and Trade Policy
Preferential arrangements with former colonies
Colonial preferences conflicted with Common External Tariff
EU made exception for these nations to avoid imposing new tariffs; signed “unilateral PTAs”
Yaoundé Convention and Arusha Agreement
When UK joined 1974 exceptions extended to many Commonwealth nations.
“ACP nations” (Africa, Caribbean & Pacific); the new agreement = Lomé Convention.
Duty-free but subject to quota for sensitive items (sugar, banana, etc.)

88. Preferential arrangements with former colonies
Theory and Politics of European Integration Lecture 4 Competition and Trade Policy
Preferential arrangements with former colonies
These didn’t help the ACP nations much
c.f. Asian success without tariff preferences
When Lomé Convention renewed in 2000, the EU and the ACP nations agreed to modernise the deal
Cotonou Agreement; eventually reciprocal free trade
stepwise reduction of tariffs on ACP nation side
general outline of principles
details fixed in bilateral Economic Partnership Agreements (EPAs)

89. Generalised System of Preferences (GSP)
Theory and Politics of European Integration Lecture 4 Competition and Trade Policy
Generalised System of Preferences (GSP)
1971 GATT provision allows tariff preferences.
EU grants GSP to almost all poor nations.
General GSP.
“Super-GSP” more generous on market access.
‘Everything but Arms’ (EBA) for least developed nations.

90. Generalised System of Preferences (GSP) (cont.)
Theory and Politics of European Integration Lecture 4 Competition and Trade Policy
Generalised System of Preferences (GSP) (cont.)
On paper, EBA grants zero-tariff access all goods, except arms and munitions.
Goods in which these nations’ are most competitive are in fact excluded from the deal.
Tariffs on bananas, rice and sugar – products where these poor nations could easily expand their EU sales – are to come down only in the future.
Moreover, even though all tariffs on these items will be gone by 2009, the exports quantities are limited by bilateral quotas.
49 nations qualify for EBA in principle in 2005.

91. Mexico, Chile, and South Africa, done.
Theory and Politics of European Integration Lecture 4 Competition and Trade Policy
Non-regional FTA
Mexico, Chile, and South Africa, done.
Ongoing with Mercosur and the Gulf Cooperation Council (Bahrain, Kuwait, Oman, Qatar, Saudi Arabia and United Arab Emirates).

92. Finally, non-preferential trade
Theory and Politics of European Integration Lecture 4 Competition and Trade Policy
Finally, non-preferential trade
Only 6 main nations: US, CAN, JAP, AUS, AT, KOR
But about 1/3rd of EU imports are not granted some sort of preferential treatment

93. NEXT LECTURE December 8, 2016, 16:00 hours
Theory and Politics of European Integration Lecture 4 Competition and Trade Policy
NEXT LECTURE
December 8, 2016, 16:00 hours