A4 privatization and regulation
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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. Nationalization and privatization. Nationalization the acquisition of private companies by the public sector

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A4 Privatization and regulation

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A4 privatization and regulation

A4Privatization and regulation

David Begg, Stanley Fischer and Rudiger Dornbusch, Economics,

6th Edition, McGraw-Hill, 2000

Power Point presentation by Peter Smith

Nationalization and privatization

Nationalization and privatization

  • Nationalization

    • the acquisition of private companies by the public sector

  • Privatization

    • the return of state enterprises to private ownership and control

Natural monopoly

The monopoly would produce

where MC=MR, with output

Qm and price Pm.

The firm makes profits

as shown.


From society's point of

view the optimum position

is at PcQ',

where MSB = MC.




Natural monopoly

occurs when there is an industry with such economies of scale

relative to market demand that only one firm can survive.






but the monopoly would make

a loss if forced to produce at

this point, with LAC > AR.


Natural monopoly 2

(1) Average cost pricing:

Firm sets P=LAC at point G;

deadweight loss reduced

to GHE.

(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






Natural monopoly (2)

Alternative pricing policies:










  • Another possibility is to nationalize the industry and provide a subsidy to cover the loss

    • as was popular in Europe in 1945-80

  • 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.

Reasons for nationalization

Reasons for nationalization

  • Natural monopoly

  • Externalities

    • e.g. subsidizing public transport (London Underground) may be a second-best option to road pricing.

  • Equity or distributional consequences

    • e.g. protecting transport in rural areas

  • Co-ordinating a network

    • e.g. British Rail could have an overview of the whole rail system

Reasons for privatization

Reasons for privatization

  • 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.

  • Pre-commitment by government not to interfere for political reasons

Privatization in practice

Privatization in practice

  • At 1997 prices, almost £67billion was raised in revenue from privatization in 1980-97.

  • In terms of widening share ownership, effects were limited

  • 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.



  • Privatization does not remove the need for regulation

  • In the UK, regulation has been through price-capping

    • privatized industries are not permitted to raise prices beyond RPI-X

      • I.e. real prices must fall.

  • 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.

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