Assess whether the benefits outweigh the costs when the Government privatises organisations such as Royal Mail and opens up the market to competition

Use the extracts and your knowledge of economics to assess whether the benefits outweigh the costs when the Government privatises organisations such as Royal Mail and opens up the market to competition. (June 2017)

• Plan
• Paragraph 1
  • Argument: privatisation and deregulation can lead to lower prices
  • Diagram: monop0listic competition
  • Evaluation: this depends on barriers to entry + CMA
• Paragraph 2
  • Argument: privatisation can lead to inefficient outcomes if natural monopolies dominate
  • Diagram: natural monopoly
  • Evaluation: depends on regulation

Privatisation is when the government sell an industry so that it is privately owned. Privatisation can be successful but this depends on the characteristics of the market structure that firms like Royal Mail compete in.

On the one hand, privatisation of organisations like Royal Mail can be good as this can lead to more competition and lower prices. This can be illustrated using models of monopolistic competition. This is when there is slight product differentiation and low barriers to entry. This can be seen in the real world as new firms such as DPD and Evri have entered the market to compete with Royal Mail. In the long run, firms like Royal Mail see a decrease in revenue as they have lower market share compared to when they had monopoly power. This leads to lower prices, p2, and firms making normal profit. The biggest advantage for consumers is that markets like this are contestable. One firm is unable to act as a price-maker in the long-run as there is always a threat that new firms can enter and compete with existing firms.

However, the extract suggests that despite some competition, Royal Mail could still have significant monopoly power. For example, in 2015 Royal Mail had 32.8% market share. Firms like Royal Mail have high output so they are able to exploit significant economies of scale, which make it difficult for new firms to compete with them. Many firms are now competing with Royal Mail for delivering packages but none for letters.

So, on the other hand, privatisation can also cause inefficient outcomes, especially if it allows a privately owned firm to act as a monopoly, or even worse a natural monopoly. A natural monopoly occurs when the most efficient number of firms in the market is one, and this becomes relevant when a firm has significant fixed costs. For example, Royal Mail have invested in postboxes all across the UK. It would therefore be inefficient for other companies to also have the same postboxes in every neighbourhood. With Royal Mail now being privately owned, the firm is motivated to maximise profits, which they can achieve where marginal costs = marginal revenue, as shown in the diagram below. The diagram shows an L-shaped long-run average cost curve as natural monopolies' economies of scale outweigh their diseconomies of scale over a much larger output than smaller firms. This leads to huge supernormal profits, and also an allocatively inefficient outcome, since, at q1, average revenues are far greater than marginal costs.

In evaluation, monopolies can be good for consumers as well. This is because supernormal profit in the long run can lead to dynamic efficiency if firms re-invest their profits. This is not guaranteed but could be likely if the firm has incentive to gain market share as it is not a pure monopoly and faces competition from DPD and other firms. Also, the government may not be able to set low prices as they would suffer from a lack of profit motive and inefficiencies as they have so many different priorities. If managing Royal Mail leads to low profits or a loss for the government, this could raise the tax bill too which is an example of negative externalities.

In conclusion, privatisation of the Royal Mail would be a good idea but only if the government is sure that the firm would not exploit its monopoly power. It can do this by ensuring that barriers to entry are sufficiently low to allow for monopolistic competition and contestability. If this does not happen, the firm would have monopoly power. This could also be good as profit can often lead to innovation but there is always the risk that they do not re-invest in their product.

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