Past Paper 2002#7 ECONOMICS PROJECT Past Paper 2002#7 By F.7A Shirley Chau (4) Catherine Chau (5) Wendy Fung (13) Joanna Lai (18)

2002 # Question 7  Today in China about half of the state-owned enterprises are persistently operating at a LOSS. Since the 1980 ’ s, the government has closed some and privatized some by either selling out or issuing marketable shares against the capital values of the enterprises. In spite of these reforms, many state- owned enterprises still remain.  A) The state-owned enterprises have long been in existence. Why were they not losing money, or at least not losing as much, before economic reforms were introduced? Why have they started to lose more and more money as economic reforms progress?  B) Why has the government not privatized all state- owned enterprises even after twenty years of reforms? (10marks)

Before the economic reforms:  Firms lose LESS money because:  Monopoly   competition   can charge a higher price (  market power)   $$$ (more revenue)   Lose less

After the economic reforms:  Firms lose MORE money because: 1. Decrease in demand  With the existence of private firms,    competition    competitive power as  quality but  price (private firms can lower the production cost by choosing the least cost method of production)   customers shift to private firms with  quality but  price    D   $$ (revenue)   Lose more

Increase in Transaction cost  What is transaction cost?  All those costs that can ’ t be conceived to exist in a Crusoe economy, they are not directly incurred in the physical process of product

After the economic reforms:  With the existence of private firms  less market power to set the price   cost to search the price   pricing cost   competitive power  promotion, advertisement   cost  TR  as TC 

P Q 0 P1 P2 Q1 MR1 D1=AR1 MC AC 1 A B LOSS 1 AC 2 LOSS 2 P4 C Q2 P3 D D2=AR2MR2 The case of state-owned enterprises

Summary: Before economic reforms: After economic reforms: < LOSS 1 LOSS 2 State-owned enterprises loss MORE after the economic reforms because of the decrease in demand and increase in transaction cost

Part B:  Why has the government not privatized all state-owned enterprises even after 20 years of reforms?  Why does the government keep on subsidizing the state-owned enterprises even though they ’ re suffering a loss?

Transaction cost?  To privatize all state-owned enterprises,  transaction cost is involved  E.g. Privatization involved some legal processes, lawyers may have to be employed   negotiation costs / contracting costs  Defining costs / delineating costs are also involved as government has to define the property rights by legal and social institutions.  Policing and enforcing costs are needed because they have to set law to ensure stable and quality production

Other Reasons~  Some production can ’ t be privatized because of reasons like:

Strategically,  E.g. iron and steel industry, weapon production  These industries cannot be privately owned as the government has to ensure its output and quality as well as the national security.

Socially,  E.g. Power station  The government has to maintain stable and sufficient supply of energy for the interest of the society.

Politically,  State-owned enterprises can provided job opportunity for the citizens which can maintain political stability.  With smaller unemployment rate, people discontent is reduced, there may not be strikes and demonstrations.  Hence, the political situation remains stable.

~THE END~ 