A4 Privatization and regulation David Begg, Stanley Fischer and Rudiger Dornbusch, Economics, 6th Edition, McGraw-Hill, 2000 Power Point presentation by.

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A4 Privatization and regulation David Begg, Stanley Fischer and Rudiger Dornbusch, Economics, 6th Edition, McGraw-Hill, 2000 Power Point presentation by Peter Smith

19.1 Nationalization and privatization n Nationalization – the acquisition of private companies by the public sector n Privatization – the return of state enterprises to private ownership and control

19.2 The firm makes profits as shown. Natural monopoly occurs when there is an industry with such economies of scale relative to market demand that only one firm can survive. DD LMC LAC MR Quantity Price QmQm PmPm The monopoly would produce where MC=MR, with output Q m and price P m. Q' PcPc From society's point of view the optimum position is at P c Q', where MSB = MC. but the monopoly would make a loss if forced to produce at this point, with LAC > AR.

19.3 (2) Two-part tariff: Firm makes a fixed charge to cover the loss made by producing at Q' (the pink rectangle), and a variable charge related to marginal cost. (1) Average cost pricing: Firm sets P=LAC at point G; deadweight loss reduced to GHE. G H Natural monopoly (2) DD LMC LAC MR Quantity Price Q' PcPc Alternative pricing policies: E

19.4 Nationalization n Another possibility is to nationalize the industry and provide a subsidy to cover the loss – as was popular in Europe in n If nationalized industries make losses, this does not prove they are failing to minimize costs or produce at the socially efficient output – but incentives may be a problem.

19.5 Reasons for nationalization n Natural monopoly n Externalities á e.g. subsidizing public transport (London Underground) may be a second-best option to road pricing. n Equity or distributional consequences á e.g. protecting transport in rural areas n Co-ordinating a network á e.g. British Rail could have an overview of the whole rail system

19.6 Reasons for privatization n Improve incentives for production efficiency – makes managers accountable to shareholders. – but sheltered monopolies will be sleepy no matter who owns them – so privatization will be most successful where there is potential for competition. n Pre-commitment by government not to interfere for political reasons

19.7 Privatization in practice n At 1997 prices, almost £67billion was raised in revenue from privatization in n In terms of widening share ownership, effects were limited n The Private Finance Initiative (PFI) is claimed as an innovative way of drawing on private-sector expertise to finance and manage public projects such as roads and hospitals.

19.8 Regulation n Privatization does not remove the need for regulation n In the UK, regulation has been through price-capping – privatized industries are not permitted to raise prices beyond RPI-X n I.e. real prices must fall. n Regulatory capture occurs when the regulating body comes to identify with the interests of the firm it regulates – eventually becoming its champion rather than its watchdog.