Foreign Direct Investment and the Single Market

(12)

Hence, the threshold tariff, which cuts off sales into each market, is: t==1 ; and the threshold
level of fixed costs consistent with locating inside the union when internal and external
barriers are equal is: ^f=0.25. The resulting sales and total profits under the different possible
regimes are summarised in the first three rows of Table 1.

3. Domestic Firm Response

Consider next how the story told in Section 2 must be amended when there are
existing firms in the union countries. As explained in the Introduction, I confine attention to
the case where there is a single incumbent firm in each union country, and assume that these
firms do not engage in cross-border investment. Even with these simplifications, a number
of new issues must be considered. Although I do not allow for entry by new firms, the
possibility that reduced internal barriers will encourage incumbents to exit from some markets
must be considered. In addition, I have to specify the nature of competition between firms.
I assume throughout that firms treat individual union markets as segmented.⁷ In the text, I
also assume that firms engage in Cournot competition, and to fix ideas I give detailed results
for the case of linear demands. The Appendices show how the conclusions are modified for
general demand functions and for Bertrand competition.

3.1 Access Costs and Equilibrium Sales

I begin by showing how the costs of serving a market affect the equilibrium sales of

⁷ Venables (1990) considers the possibility that trade liberalisation may encourage firms to
treat markets which were previously segmented as integrated, so that output and pricing
decisions are taken for the union as a whole.

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