Definitions, advantages and disadvantages of privatisation

1. The Basic Economic Problem

1.1 Scarcity and Choice

• Scarcity: Limited resources (land, labour, capital, entrepreneurship) relative to unlimited wants.
• Economic goods vs. free goods: Economic goods are scarce and have a price; free goods are abundant and have no price (e.g., air).
• Choice: Because of scarcity, societies must decide what to produce, how to produce it and for whom.

1.2 Opportunity Cost

The value of the next best alternative foregone when a choice is made. Represented by the slope of the Production Possibility Curve (PPC).

1.3 Production Possibility Curve (PPC)

2. Allocation of Resources in Markets

2.1 Demand and Supply

• Demand: Quantity of a good consumers are willing and able to buy at each price (downward‑sloping curve).
• Supply: Quantity of a good producers are willing and able to sell at each price (upward‑sloping curve).
• Market equilibrium: Intersection of demand and supply – determines equilibrium price (P_e) and quantity (Q_e).

2.1.1 Shifts of the curves

Factor	Demand shift	Supply shift
Change in income (normal good)	Right (increase)	–
Change in income (inferior good)	Left (decrease)	–
Change in price of related good	Substitutes: right; Complements: left	–
Technology improvement	–	Right (increase)
Input price rise	–	Left (decrease)
Government tax on the good	Left (decrease)	Left (decrease)

2.2 Price Elasticity

2.2.1 Price Elasticity of Demand (PED)

PED = % change in quantity demanded ÷ % change in price.

• Elastic (|PED| > 1): quantity responds strongly – e.g., luxury cars.
• Inelastic (|PED| < 1): quantity responds weakly – e.g., petrol in the short‑run.
• Unit‑elastic (|PED| = 1).

2.2.2 Price Elasticity of Supply (PES)

PES = % change in quantity supplied ÷ % change in price.

• Elastic supply when producers can increase output quickly (e.g., manufactured goods).
• Inelastic supply when production is time‑consuming (e.g., agricultural crops).

2.3 Market Failure

When the free market does not allocate resources efficiently.

• Public goods: Non‑rival & non‑excludable (e.g., national defence).
• Merit goods: Under‑consumed if left to the market (e.g., education, vaccination).
• Demerit goods: Over‑consumed if left to the market (e.g., cigarettes).
• Externalities: Costs or benefits that affect third parties (negative: pollution; positive: R&D spill‑overs).
• Monopoly: Single seller can restrict output and raise price.
• Information asymmetry: One party has more/better information (e.g., used‑car market).

3. Economic Systems

3.1 Market (Capitalist) Economy

• Resource allocation by price mechanism.
• Advantages: high efficiency, innovation, consumer choice.
• Disadvantages: inequality, provision of public goods may be inadequate.

3.2 Command (Planned) Economy

• State decides what, how and for whom to produce.
• Advantages: can achieve rapid mobilisation, equity in theory.
• Disadvantages: inefficiency, lack of incentives, shortages.

3.3 Mixed (Hybrid) Economy

• Combines market mechanisms with government intervention.
• Goal: retain efficiency while correcting market failures and promoting equity.

3.3.1 Arguments **for** a mixed system

• Balances efficiency (market) with equity (government).
• Allows correction of market failures (e.g., externalities, public goods).
• Provides policy flexibility (taxes, subsidies, regulation, privatisation, etc.).

3.3.2 Arguments **against** a mixed system

• Potential conflict between profit motives and political objectives.
• Risk of “government failure” if interventions are poorly designed.
• Complexity can create uncertainty for businesses and consumers.

4. Government Intervention Tools

Intervention	Purpose / Typical Use	Brief Definition
Price ceiling (max)	Protect consumers from excessively high prices (e.g., essential food items)	Legal limit on the highest price that can be charged.
Price floor (min)	Support producers (e.g., agricultural markets)	Legal limit on the lowest price that can be charged.
Indirect tax	Correct negative externalities, raise revenue	Tax added to the price of a good or service (e.g., VAT, excise duty).
Subsidy	Encourage positive externalities, make essential goods affordable	Financial assistance from the government to producers or consumers.
Regulation	Control quality, safety, competition or environmental impact	Legal rules that firms must follow (e.g., health‑and‑safety standards).
Privatisation	Transfer public assets to private ownership to improve efficiency, raise revenue, reduce fiscal burden.	Sale, lease or contract‑out of a state‑owned enterprise or service to the private sector.
Nationalisation	Bring a private firm under state control to secure strategic services or correct market failure.	Government acquires ownership of a previously private enterprise.
Direct provision	Deliver essential services directly by the state (e.g., education, health).	Government produces and delivers the good/service itself.
Quotas	Limit quantity of a good to protect resources or domestic producers.	Legal limit on the amount that can be produced, imported or sold.

5. Privatisation

5.1 Definition

Privatisation is the transfer of ownership, control or management of an enterprise or service from the public sector to the private sector. Main methods:

• Sale of shares or the whole business.
• Leasing of assets.
• Contracting‑out (outsourcing) of services.
• Management buy‑outs.

5.2 Why Governments Choose Privatisation (in a Mixed Economy)

1. Raise immediate revenue for the state budget (e.g., sale of British Telecom, 1984).
2. Improve efficiency and productivity by exposing firms to profit motives and competition.
3. Reduce fiscal burden – loss‑making public enterprises no longer require subsidies.
4. Encourage competition in sectors previously monopolised (e.g., electricity distribution).
5. Broaden share ownership and develop a “shareholder culture”.
6. Shift risk from the state to private investors.

5.3 Privatisation and Market Failure

Privatisation is considered when a market failure can be better addressed by private provision under regulation.

• Monopoly: Transform a state monopoly into a regulated private firm or open the market to competition.
• Inefficient state enterprise: Chronic losses suggest managerial failure; private ownership can impose cost discipline.
• Public‑good provision with high transaction costs: Private contractors may deliver services more efficiently if performance standards are set.

5.4 Advantages of Privatisation

• Improved efficiency – profit motive drives cost‑cutting, innovation and better customer service.
• One‑off revenue generation – cash inflow can reduce public debt or fund other priorities.
• Reduced fiscal burden – loss‑making firms no longer need subsidies.
• Stimulates competition – can lower prices and raise quality if entry barriers fall.
• Wider share ownership – public share issues increase financial literacy and broaden the investor base.
• Better resource allocation – market signals direct capital to more productive uses.

5.5 Disadvantages / Potential Problems

• Job losses – private owners may reduce staff to improve profitability.
• Profit over public interest – essential services may become unaffordable for low‑income groups.
• Creation of private monopolies – without effective competition, a privatised firm can charge higher prices.
• Asset stripping – owners may sell valuable assets for short‑term gain, harming long‑term productivity.
• Regulatory challenges – strong, independent regulators are required; they can be costly and politically sensitive.
• Equity concerns – wealth may become concentrated if shares are bought mainly by large investors.

5.6 Evaluation of Privatisation

Evaluation Criterion	Positive Impact (Potential)	Negative Impact (Potential)
Efficiency & productivity	Higher output, lower unit costs, greater innovation.	Cost‑cutting may reduce service quality or safety.
Fiscal effect	One‑off cash inflow; long‑term savings on subsidies.	Loss of future dividend income and possible higher regulatory costs.
Consumer welfare	More choices, lower prices if competition emerges.	Higher prices if a private monopoly forms; reduced access for vulnerable groups.
Employment	Potential for new private‑sector jobs; retraining opportunities.	Redundancies in the short‑term; loss of public‑sector job security.
Equity & access	Share‑ownership schemes can widen participation.	Wealth concentration; essential services may become less universal.
Regulatory capacity	Creates a clear framework for monitoring performance.	Requires strong, well‑funded regulators; risk of regulatory capture.

5.7 When is Privatisation Preferable?

• There is a realistic prospect of competition or effective regulation.
• The firm is loss‑making and a fiscal burden on the state.
• The government needs a large, immediate cash injection.
• The service does not require universal access that only the state can guarantee.
• Clear, enforceable performance standards can be set (e.g., through contracts or regulatory bodies).

5.8 Comparative Table: Public vs. Private Ownership

Aspect	Public Ownership	Private Ownership
Primary Objective	Provision of public services, social welfare	Profit maximisation
Decision‑making speed	Often slower – bureaucracy and political consultation	Generally faster – market‑driven decisions
Funding source	Tax revenue, government borrowing	Private capital, market financing
Accountability	To elected officials and the public	To shareholders and regulators
Risk of inefficiency	Higher – less profit pressure	Lower – profit motive encourages efficiency
Equity considerations	Explicit – universal access, subsidies	Implicit – may be addressed through regulation

5.9 Evaluation Checklist for a Privatisation Proposal

1. Will the one‑off revenue outweigh any long‑term loss of dividend income?
2. Is there a realistic prospect of competition emerging, or will a private monopoly arise?
3. How will vulnerable consumers be protected from possible price rises?
4. What measures (e.g., retraining schemes, employment guarantees) will safeguard jobs?
5. Is the regulatory framework strong, independent and adequately funded to prevent market abuse?
6. Does the proposal include mechanisms for wider share ownership or public participation?
7. How does privatisation compare with alternative tools (regulation, direct provision, nationalisation) for the specific market failure?

5.10 Suggested Diagram – Privatisation Process

6. Micro‑Decision‑Makers (Key Concepts for AO3)

6.1 Households

• Influences on consumption: income, interest rates, wealth, expectations, culture, age.
• Budget constraint: Income = Expenditure on all goods + Savings.

6.2 Firms

• Goal: maximise profit (TR – TC).
• Revenue: TR = P × Q.
• Cost concepts: Fixed Cost (FC), Variable Cost (VC), Total Cost (TC = FC + VC), Average Cost (AC = TC/Q), Marginal Cost (MC = ΔTC/ΔQ).
• Short‑run vs. long‑run cost curves (U‑shaped AC and MC).
• Economies of scale – lower AC as output rises.

6.3 Workers

• Labour‑market influences: wages, skills, education, trade unions, minimum wage legislation.
• Wage determination in competitive labour markets vs. monopsony.

6.4 Money & Banking (Brief Overview)

• Functions of money: medium of exchange, unit of account, store of value.
• Central bank (e.g., Bank of England) controls monetary policy – interest rates, reserve requirements.
• Commercial banks create money through the multiplier effect.

7. Government & the Macro‑Economy (AO2 & AO3)

7.1 Macroeconomic Aims

• Economic growth (increase in real GDP).
• Low unemployment.
• Price stability (low inflation).
• External balance (stable current account).
• Equitable distribution of income.

7.2 Fiscal Policy

• Expansionary: Increase government spending or cut taxes → boost AD.
• Contractionary: Decrease spending or raise taxes → reduce AD.
• Multiplier effect – change in equilibrium output = multiplier × change in autonomous expenditure.

7.3 Monetary Policy

• Tools: interest rates, open‑market operations, reserve requirements.
• Expansionary: lower interest rates → increase investment and consumption.
• Contractionary: raise rates → dampen inflationary pressure.

7.4 Supply‑Side Policies

• Improve productive capacity: investment in infrastructure, education, R&D, deregulation, tax incentives.
• Goal: shift LRAS rightwards, increase potential output.

7.5 Interaction with Privatisation

Privatisation is a supply‑side measure that can:

• Reduce the fiscal deficit (fewer subsidies).
• Potentially increase long‑run productive capacity if efficiency gains are realised.
• Require complementary policies (e.g., regulation) to safeguard macro‑economic stability.

8. Key Take‑aways

• The basic economic problem of scarcity forces societies to choose what, how and for whom to produce.
• Markets allocate resources through the price mechanism; however, market failures may justify government intervention.
• A mixed economy blends market efficiency with state action to achieve both growth and equity.
• Privatisation transfers public assets to the private sector; its success depends on the design of the sale, the presence of competition, and a robust regulatory framework.
• When evaluating privatisation, weigh short‑term fiscal gains against long‑term impacts on efficiency, consumer welfare, employment and equity.
• Understanding the broader macro‑economic context (fiscal, monetary and supply‑side policies) is essential for assessing the overall effectiveness of privatisation as a policy tool.