Module:Managerial Economics (MBA50)

Academic Year: 2014-15

4thWritten Assignment (WA 4)

Please answer all 3questions

Subject 1: EU Competition Policy (40%)

A. Assume that in Denmark there are only two firms, Fage and Danone, which sell Greek
yogurt. These firms face the same constant marginal cost,their products are identical
and they compete in quantities(i.e., they choose their quantities simultaneously and
separately).Assume also that there are no substitutes for Greek yogurt and that no
other firm is considering entering into the market.What will happen to the price and
the quantity of Greek yogurt in Denmark if the two firms merge among them? Will
their merger decrease welfare, yes or no, and why? [Hint: Do not use calculations in
your answer butdo use a diagram].(Mark: 1.3)
B. Why is it important that the relevant market is correctly definedby the competition
policy authorities? Provide a general answer as well as a separate answer for the case of a
merger and for the case of abuse of dominant position.(Mark: 0.7)

C.The European Commission discovered in the past a cartel in the beer market of the
Netherlands. Which firms participated in the cartel? What were their actions and the
economic rationale behind them? How was the cartel found and proved? What was the
final decision of the European Commission? What do you think were the main goals of
this decision?[Hint: Use official sources that can be found online on the European
Commissions website].(Mark: 2.0)
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Indicative Answer:
A. What would happen in the price and quantity of Greek yogurt in Denmark if the two firms merge among
them?
The merger will change the market structure from oligopoly to monopoly. Thus, there will be a decrease in
market competition. If the marginal cost remains the same after the merger (i.e., if there are no efficiency
gains), then the price will increase and the total quantity will decrease. If instead, there are strong efficiency
gains, then the price could remain the same or even decrease and the total quantity respectively could remain
the same or increase.
Will their merger decrease welfare, yes or no, and why?
If there are no efficiency gains, then the merger will decrease welfare. In particular, since the price will
increase and the quantity decrease, the consumers surplus will be lower after the merger. The producer
surplus will be higher but due to the decrease in the total quantity, total welfare will be lower. In particular,
in the figure below pNM and QNM denote respectively the price and the total quantity without the merger while
pM and QM denote respectively the price and the total quantity with the merger.
Before the merger, welfare is given by areas +++++++.
After the merger, welfare is given by areas +++++
Thus, the merger will result into a decrease in welfare equal to area THETA+E.

If there are efficiency gains, i.e., if the marginal cost of the merged firm reduces after the merger then it is
not necessary true that the merger will reduce welfare.

Moreover, the merger could change the incentives for future investments in R&D if it increases these
incentives, then perhaps the merger could even lead to an increase in dynamic welfare.
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B. If the relevant market is not defined correctly, the competition policy authorities will make the wrong
conclusions about the characteristics of the market (e.g., number of firms in the market, market share of each
firm), and thus, about the importance and the consequences of the practice under investigation.
If the definition of the relevant market is not correct, then:

-In the case of a merger, the competition authorities will not be able to evaluate correctly the extent of the
unilateral effects of the merger, i.e., the change that the merger will cause on the monopoly power, since the
latter crucially depends on the firms market share.

- In the case of abuse of dominant position, the competition authorities might end up concluding that a firm
does not have a large market share and thus that it does not have a dominant position in position. In other
words, they might end up concluding that there is no case of an abuse of dominant position.

C. Which firms participated in the cartel?

Heineken, Grolsch, Bavaria, InBev.

What were their actions and the economic rationale behind them?

Between 1996 and 1999, the four firms held many unofficial meetings. At these meetings, they coordinated
their prices and price increases of beer in the Netherlands, both in the on-trade segment of the market (where
consumption is on the premises) and the off-trade market segment (consumption off the premises - mainly
sold through supermarkets), including private label beer. In the on-trade market segment, the firms
coordinated the rebates granted to pubs and bars. Moreover, they occasionally coordinated other commercial
conditions offered to individual customers in the on-trade segment and engaged in customer allocation, both
in the on- trade and the off-trade segment.

The economic rationale for their actions was to avoid competition among them that would drive their
prices and profits down.

How was the cartel found and proved?

InBev informed the Commission of the existence of the infringement through the application of the
Leniency program.The Commission launched then an investigation. InBev provided documentation to the
Commission that was crucially important to confirming the existence of a cartel.
The evidence uncovered was hand-written notes taken at unofficial meetings.The evidence found showed
that that in all four brewerygroups high-ranking management participated in the cartel meetings. There was
also evidence that the companies were aware that their behavior was illegal and took measures to avoid
detection, such as using code names and abbreviations to refer to their unofficial meetings and holding these
meetings in hotels and restaurants.

What was the final decision of the European Commission?

The firms involved in the cartel had to immediately bring to an end the infringements, insofar as they had not
already done so. They had to refrain from any act or conduct as the infringement found in this case, and from
any act or conduct having the same or a similar object or effect.
Moreover, the firms had to pay the following fines: Heineken 219.275.000 euros, Grolsch 31.658.000
euros, Bavaria 22.850.000 euros, InBev 0 euros (due to the participation in the Leniency program).

What do you think were the main goals of this decision?

The main goals for the imposition of the decision were:

1. Punishment of the firms involved in the cartel.
2. Cartel deterrence, i.e., to deter the firms involved in the cartel, as well as any other firm in any other
market from entering into illegal behavior in the future. In particular, the violation of the competition law is
profitable if it goes unpunished. This is the main motive for the violations. If there is a sufficient punishment,
firms might think twice before forming a cartel.
3. Provide incentives for the participation in the Leniency program.

(The above answers can be found in various sites including the EUs website. In particular in:
http://ec.europa.eu/competition/publications/cpn/2007_3_55.pdf
http://ec.europa.eu/competition/elojade/isef/case_details.cfm?proc_code=1_37766
http://eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri=CELEX:52008XC0520(01)&from=EN )

Subject 2: The Greek economy in the era of Memoranda of Understanding (30%)

In a recent New York Times article, titled Europes Greek Test, PaulKrugman, implying the internal
devaluation imposed on the Greek economy, points out that Greece has actually made great progress in
regaining competitiveness; wages and costs have fallen dramatically...
http://www.nytimes.com/2015/01/30/opinion/paul-krugman-europes-greektest.html?rref=collection%2Fcolumn%2Fpaul-krugman
Has the internal devaluation policy,introduced to boost Greek exports by dramatically reducing labor
costsso far considerably increasedGreek exports over the period 2010-2014?Using official statistics of the
European Commission (Annual Macroeconomic Database), discuss the trend of the price level of the
exported goods and Greek exports in relation to the unit labor cost over the same period. What do you
observe? (Mark: 1)

Over the last two years we can notice a remarkable improvement in the countrys trade deficit. What is the
main driving force behind this improvement? What is your main conclusion from your discussion of (A) and
(B)? (Mark: 0,5)
Discuss three main reforms that the Memoranda of Understanding (Mnimonia) from May 2010 to November
2012 have introduced into the Greek labor market. Referring to the pertinent laws associated with
thesereforms, explain why you consider them important for the Greek economy. (Mark: 1,5)

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Indicative Answer:
A.Looking at the EU official data (table below), it is obvious that Krugmans observation about rising
competitiveness was accurate. Indeed, a persistent austerity policy implemented in the memoranda of
understanding between Greece and Troika has led to increasing competitiveness as it is depicted in the deescalation of the Greek unit labor cost over the 2012-2014 period.
However, such a profound decline in labor costs has not led to a sharp reduction in prices of Greek exports.
The price deflator of exports has been reduced at a slower pace. One could expect this since during this
period other production costs, mainly energy and financial costs were rising. So, as far as the production
costs are concerned, the internal devaluation, as a single driving force, has not led to an export boost. Rather,
data on Greek exports show a very mild increase in recent years.

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ULC

PDExp

Exp (at 2010

Imp (at 2010

prices)

prices)

2010

100

100

50

69.4

2011

99,1

105,8

50

63.1

2012

95,7

108,5

50.6

57.4

2013

91,1

106,8

51.6

56.4

2014

91,4

104,9

55.8

59.1

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B.Looking at the data on Greek imports, one can observe that we have a sharp decline in imports due to
austerity policies based on shrinking wages, pensions, and mounting unemployment that led to an impressive
trend of declining imports.
So a general conclusion that can be drawn is that the part of the austerity program that engineered an internal
devaluation by slashing labor costs to lead to an export-based economic recovery has failed. Improvement in
the Greek current account came not from rising exports but from sharply declining imports.

Thus internal devaluation has an impact on improving trade deficit by reducing imports rather than boosting
exports and leading to an economic recovery!

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C. The Memoranda of Understanding between the Troika and Greece have imposed some fundamental
reforms in the Greek labor market. One of the most important reforms was the provision that a collective
agreement at enterprise level can deviate from the collective agreement at industry level on wage
increases and working conditions (Law 3899/2010). It is a labor flexibility measure enhancing the
management prerogative and allowing individual employers to align their companys labor costs to the
specific competition conditions that they face, and therefore being able to stay competitive in the
marketplace.
Another fundamental institutional change in the labor market is that the National General Collective
Agreement ceases to determine the minimum wage rate. Based on Law 4046/12, the minister of Labor, after
consultations with the social partners ( trade unions and employers), can bringa law to the parliament that
institutionalizes the change in the minimum wage.
A third important change in the labor market institutional regime is the deregulation of the lay-offs in Greece.
Based on Law 4093/2012, an employer needs to inform an employee about the decision to fire him / her in 4
months compared to the prior regulation that required a relevant warning of 24 months. In addition, the cost
of firings has been reduced. For lay-offs without warning, the severance pay has been reduced from 24
salaries to 12 salaries, for employees with more than 16 years of employment.

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Subject 3: European Union as a case of Regional Economic Integration and Foreign Direct
Investment (30%)
A. By using the data of Table 1 comment on the distribution pattern and its change of the inward stock of
Foreign Direct Investment (FDI) to the European Union-15 between 1980 and 1998. Particular reference
should be made on the FDI concentration pattern and its intertemporal change both by country and by
aggregating country members to two groups, i.e. geographical core and noncore countries. Extendyour
analysis by distinguishing between FDI originated outside the EU-15 and within the EU-15 using the
data of Table 2. Hint: EU-15 is the domain of both data and analysis for the reason of making
consistent comparisons over time. (Mark:1,2)

B. Conclude your analysis by commenting on the influence of regional economic integration, and the
internal market program that led to the emergence of the single European-15 market in particular on both the
FDI level and geographic patterns in the EU-15. Give your interpretation on both the inward FDI level and
patterns emerging in the increasingly integrated European-15market. Hint: In drafting your interpretation use
among others the concepts of economies of scale, economies of scope, trade and market openness as
determinants of FDI. (Mark:1,8)

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Table 1: Percentage Distribution of FDI Inward Stock by Host Country

HOST COUNTRY

YEAR
1980

1985

1990

1995

1998

Core Countries

85.1

83.3

82.3

77.5

78.9

Belgium and Luxemburg

3.9

7.8

7.9

10.9

11.0

France

12.3

14.2

11.7

13.5

12.0

Germany

19.8

15.6

15.1

15.6

15.4

Italy

4.8

8.0

7.9

5.9

7.1

Netherlands

10.3

10.6

10.0

11.6

11.4

United Kingdom

34.0

27.1

29.7

20.0

22.0

Non core Countries

14.8

16.6

17.7

22.3

20.9

Austria

1.7

1.6

1.3

1.6

1.7

Denmark

2.3

1.5

1.2

2.0

2.1

Finland

0.3

0.6

0.7

0.8

1.0

Greece

2.4

3.5

1.9

1.8

1.5

Ireland

2.0

2.0

0.7

1.1

1.6

Portugal

1.3

1.5

1.3

1.6

1.4

Spain

2.8

3.8

8.9

10.5

8.0

Sweden

2.0

2.1

1.7

2.9

3.6

European Union 15 (% of world total)

36.3

30.3

41.7

38.2

36.4

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Table2: Percentage Distribution of FDI flowsby Home Region, % annual of total

Non EU 15 Home Region
Host Region

EU- 15

1985-87

1988-90

1991-93

1995-97

55.8

61.6

64.5

65.1

EU15 Home Region

Host Region

EU-15

1985-87

1988-90

1991-93

1995-97

30.6

50.8

57.7

58.2

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Indicative Answer
A. The data reveals an increase in FDI activity in the EU in the second half of the 80s, which partly may be
attributed to adjustments initiated by the Internal Market Program. The distribution of FDI stock in the
EU shows that the core countries receive more than two third (2/3) of total FDI destined to the EU, with
the UK being the most favoured host country, although its importance has become lower than it was in
the mid 80s. Four countries, i.e. the UK, Germany, France, and the Netherlands concentrated 76.4% of
total inward FDI stock in the EU-15 in 1980, a percentage that went down to almost 61% in 1998 in
favour of mainly Belgium - Luxemburg, the percentage share of which increased from almost 4.0% to
11.0% in the same period. Spain enjoyed a considerable increase of FDI inflows after her accession to
the EU and Sweden seems to be a similar case. These two host countries, especially Spain are the main
reasons for the decrease of concentration of FDI stock in favour of the non-core countries. In any case it
cannot be argued that economic integration affected considerably the decentralization of FDI inflows in
the EU in general.
The EU is the main host region, for FDI originated by EU countries. Intra-EU FDI increased from 30.6% of
total EU outward FDI flows in average terms in 1985-87 to more than 58.0% ten years later.

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B.
The abolition of trade barriers has a trade creation effect and the subsequent substitution of FDI aiming at
avoiding trade barriers by intra-region trade.
The market enlargement effect facilitates the realization of economies of scale. That may induce FDI
originated outside the European common market and being market seeking in nature Such FDI may produce
at a single site and market its output to the European common market as a whole. This effect is expected to
be more prominent in sectors of high plant economies of scale and of low transportation cost.
In oligopolistic sectors of differentiated products as increasing economic integration promotes the
efficiency of insider firms outsiders may be motivated to locate production in the integrated region
seeking better competitive positions. Local production takes advantage of: a) economies of scale, b) local
sources of competitiveness (agglomeration economies), and c) better adaptation to intra-regional demand
variations (product differentiation, after sales services, etc.).

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The emerging single market rises the scope for production rationalization and the building of a regionally
integrated network of affiliated firms under common ownership, that takes advantage of local supply
conditions differentiation, free intra-firm trade and the lowering of cross border coordination cost through the
inter-country convergence of institutions, policies, attitudes, codes of behavior, etc and the deregulation of
market transactions. Strategic asset seeking FDI is also facilitated in its effort to access intangible country
idiosyncratic resources subject to culture, institutions and agglomeration economies by lower coordination
and transfer costs in a liberalized regional market. An effect of that process may be an intra-regional
geographical concentration of similar activities and products.
Marketing intensive FDI will continue to flow by establishing R&D facilities, dealer networks, after sales
and maintenance services within individual markets.
Firms will continue to exploit intangible firm specific income and market power generating resources, such
as brand names, managerial expertise and other non-codified information intensive assets via common
ownership, i.e. FDI rather than licensing or other arms length transactions.
FDI in the tertiary sector, especially in banking, financial services, telecommunications, etc. is also expected
to increase due to deregulation of national markets.

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Assignment guidelines
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