Chapter 18 Natural monopoly: public or private?

1. Chapter 18Natural 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. 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. Natural monopoly From society's point of view the optimum position is at PcQ', whereMSB= LMC Pc Q' occurs when there is an industry with such economies of scale relative to market demand that only one firm can survive. The monopoly would produce where MC=MR, with output Qm and price Pm and make the profits shown. Price Pm LAC but the monopoly would make a loss if forced to produce at this point, with LAC > AR. LMC DD MR Qm Quantity

4. 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 green rectangle), and a variable charge (Pc) related to marginal cost. G Pc H Q' Alternative pricing policies: Price LAC LMC E DD MR Quantity

5. 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. 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. 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. 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. 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. 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. PFI (2) Insert table 18.2

12. 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