1. © The McGraw-Hill Companies, 2008 Chapter 18 Natural monopoly: public or private? David Begg, Stanley Fischer and Rudiger Dornbusch, Economics, 9th Edition, McGraw-Hill, 2008 PowerPoint presentation by Alex Tackie and Damian Ward

2. © The McGraw-Hill Companies, 2008 Nationalization and privatization Nationalization –the acquisition of private companies by the public sector Privatization –the return of state enterprises to private ownership and control

3. © The McGraw-Hill Companies, 2008 Natural monopoly occurs when there is an industry with such economies of scale relative to market demand that only one firm can survive. LMC DD LAC MR Quantity Price The monopoly would produce where MC=MR, with output Q m and price P m and make the profits shown. QmQm PmPm Q' PcPc From society's point of view the optimum position is at P c Q', where MSB = LMC but the monopoly would make a loss if forced to produce at this point, with LAC > AR.

4. © The McGraw-Hill Companies, 2008 (2) Two-part tariff: firm makes a fixed charge to cover the loss made by producing at Q' (the green rectangle), and a variable charge (P c ) related to marginal cost. Natural monopoly (2) DD LMC LAC MR Quantity Price Q' PcPc Alternative pricing policies: E (1) Average cost pricing: Firm sets P=LAC at point G; deadweight loss reduced to GHE. H G

5. © The McGraw-Hill Companies, 2008 Nationalization 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 minimise costs or produce at the socially efficient output –but incentives may be a problem.

6. © The McGraw-Hill Companies, 2008 Reasons for nationalization Natural monopoly Externalities –e.g. subsidising 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

7. © The McGraw-Hill Companies, 2008 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

8. © The McGraw-Hill Companies, 2008 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.

9. © The McGraw-Hill Companies, 2008 Regulation 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.

10. © The McGraw-Hill Companies, 2008 Public Finance Initiative Deals between central government and private companies to deliver large infrastructure projects, e.g. Channel Tunnel rail link. Public Private Partnerships, PPP’s are the same but between local governments and private companies A means of transferring cost burdens from current taxpayers to future tax payers

11. © The McGraw-Hill Companies, 2008 PFI (2) Insert table 18.2

12. © The McGraw-Hill Companies, 2008 PFI Benefits and Problems Draws on the construction, financing and risk management expertise of the private sector Private sector takes responsibility for cost overruns But cost runs aren’t borne by the private sector and Sometimes the private sector partners would rather be declared bankrupt and leave the public sector with the cost of completing the project