Nationalisation

Overview

Nationalisation regarded as a possible remedy for market power, main arguments in favour of nationalisation and main arguments against nationalisation.

What you need to know

Answer each one before you reveal it.

Questions from this subtopic

Each one with the model answer underneath.

1. 1

   What is nationalisation?

   Model answer

   Nationalisation is the transfer of an industry or firm from private into public ownership, so that it is owned by the state and run according to objectives the government sets rather than to maximise profit for shareholders.

2. 2

   What is privatisation?

   Model answer

   Privatisation is the transfer of a state-owned industry or firm into private ownership, usually by selling shares to investors or selling the business to another company, so that it is thereafter run for profit and subject to the disciplines and incentives of private capital.

3. 3

   Why is nationalisation regarded as a possible remedy for market power?

   Model answer

   Because the harm from monopoly comes from a firm pricing to maximise profit, and a state-owned firm can be instructed not to. If it is told to set price equal to marginal cost, output rises all the way to the efficient level and the whole deadweight loss disappears. If it is told merely to cover its costs, price falls to average cost and output rises only part of the way, because average cost lies above marginal cost wherever fixed costs are large. Either way the surplus that would have gone to shareholders stays with consumers, and the remedy removes the motive for the harmful behaviour rather than merely restraining it.

4. 4

   A firm faces demand P = 100 - 2Q and has total cost TC = 30 + 10Q + Q squared. In private hands it produces 15 units at £70. Calculate the price, output and profit if the state took it over and instructed it to price at marginal cost.

   Model answer

   Marginal cost pricing requires 100 - 2Q = 10 + 2Q, so 4Q = 90 and Q = 22.5 units at a price of £55. Total revenue is £1,237.50 and total cost is 30 + 225 + 506.25 = £761.25, so the firm makes a surplus of £476.25. Output rises by 7.5 units, price falls by £15, and total welfare rises by £112.50, the deadweight loss that private profit maximisation had created.

5. 5

   In the nationalisation example the firm still earns a surplus of £476.25 when it prices at marginal cost. Explain why this is so, and why the result would differ for a natural monopoly.

   Model answer

   With total cost TC = 30 + 10Q + Q squared, average cost reaches its minimum at about 5.5 units and rises after that, so at 22.5 units marginal cost of £55 is above average cost of about £33.83 and the firm covers its costs comfortably. A natural monopoly has average cost falling throughout the relevant range, which means marginal cost lies below average cost everywhere. Pricing at marginal cost then means pricing below average cost, so the firm makes a loss and requires a subsidy from the taxpayer to continue. This is the central financial difficulty of marginal cost pricing in the industries where nationalisation is usually proposed.

6. 6

   What objectives other than profit might a nationalised industry be given?

   Model answer

   It may be required to supply everyone at a common price regardless of the cost of serving them, so that remote areas are not abandoned. It may be told to keep prices affordable for essentials, to maintain employment in particular regions, to invest for the long term ahead of demand, to meet environmental targets, or to maintain a strategic capacity the country would need in an emergency. Each of these can conflict with cost minimisation.

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