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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

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.