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Privatization Prices

© Allen C. Goodman, 2015

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Degrees of Public and Private Involvement

Case Choice Financing Production Example1 Public Public Public Police

2 Public Public Private Trash

3 Public Private Private Sidewalks

4 Private Private Private Private Goods

Privatization

• Definition: Transfer production of government services to private firms.

Degrees of Public and Private Involvement

Case Choice Financing Production Example1 Public Public Public Police

2 Public Public Private Trash

3 Public Private Private Sidewalks

4 Private Private Private Private Goods

Think of some of your own examples!

Think of some of your own examples!

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How might privatization ↓ costs?

• Lower labor costs– Lower wages?– Lower fringes?

• Different production approaches– Different mixes of capital and/or labor?– Fewer or different political problems?

• More R&D– More focused on lowering costs?

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Why might it not work well?

• Contracting issues.– How much competition is there in the supply

sector? If there are monopolistic suppliers you may not get competitive bidding.

– Specifying the amount or quality of services. What is “good” education? For example, how do you evaluate vouchers or charter schools.

– Monitoring the services. How do you know they’re giving you what you contracted for?Some of the same issues

occur in the public sectorprovided publicly.

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What gets privatized?

• Some is pretty obvious– Towing cars– Waste facilities– Athletic facilities– Driver training

• Other stuff is less obvious, more controversial– Education– Fire protection

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So, what seems to work?

• Lower costs seem to come from lower wages or lower benefits.

• Some have found that if there is more competition in provision, costs are lower, but that depends critically on there being competition.

• If the competitors “carve up” the territory, then you won’t have competition, or lower costs.

Wages

Benefits

Who pays for benefits?

• Start with no benefits.Labor Market

Demand Supply

W0

L0 Labor

• Suppose that they negotiate $2/hour in benefits.

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2

• Why?

• Who pays?

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User Charges

• Economists like markets. With a market, those who want the good will pay for it; those who don’t, won’t.

• Let’s look at parking at Wayne. Should it be free? After all you’ve spent a lot of tuition.

• If it’s free, is someone subsidizing someone else?

• If it’s free, are there any costs?

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Good user charge model

• Let’s go back to the optimal level of public services.

• MBS = MB to “society” – it’s good to have parking for guests who visit.

• MBU = MB to users – those who park everyday.

MC

MBS

MBU

MBU+MBS= MC

QuantityQ*

Price$

Why is it kinked?

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Good user charge model

• Let’s put in a couple of other benchmarks.

• At Q1, society’s needs are met. Anything more accrues solely to users.

• If we charge 0 price, we’ll get a demand of Q2.

MC

MBS

MBU

MBU+MBS= MC

QuantityQ*

$

Q1 Q2

Price

EfficiencyLoss

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Good user charge model

• We’ve seen MB*U and MB*S before.

• “Clearly” users should pay (MB*U/MC) fraction of the costs of the facility.

• What does this tell us about potential user charges?

MC

MBS

MBU

MBU+MBS= MC

QuantityQ*

$

Q1 Q2

Price

MB*S

MB*U

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Good user charge model

1. Greater the fraction of MC that MBU are, the more attractive are user charges.

2. User-charge financing requires that we be able to identify users easily.

3. Efficiency case for user charges is stronger the more elastic is demand. Why?

MC

MBS

MBU

MBU+MBS= MC

QuantityQ*

$

Q1 Q2

Price

MB*S

MB*U

A> It’s all aboutQuantity!

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Good user charge model

4. Marginal benefits, NOT total benefits, matter. Past Q1, all of the incremental benefits go to the users, as opposed to society. They should finance entirely ALL of the costs of facilities past Q1.

MC

MBS

MBU

MBU+MBS= MC

QuantityQ*

$

Q1 Q2

Price

MB*S

MB*U

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Three Kinds of Costs

• Capital Costs – What does it cost to HAVE the facility? How do we pay for it?– Probably $/head, $/property, $/value of

property.

• Operating Costs – What does it cost to USE the facility? Some sort of user charge. Might it be 0?

• Congestion Costs – What are congestion costs? How do we charge?

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Prime Example – Highways

• What are the MPC?• What are the MSC?

Cars/hr.

MPC

MSC

D (5 am)D (5 pm)

$

• Why does demand differ at different times of the day?

• What is the efficient price? Why?

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Prime Example – Highways

• People are valuing others’ time at 0. The price system is not working properly.

• Appropriate congestion tax is t.

Cars/hr.

MPC

MSC

D (5 am)D (5 pm)

t

$

• What are the impacts?– Gives drivers incentives to

drive at less congested times.

– Redistributes costs from non-users to users

Loss

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What do you do with tax

• Here, a tax is used to fix price system.• Think of a situation where you take the

congestion taxes and use them to redistribute to everyone else.

• So, the users are worse off … but the non-users, who were subsidizing them, are now better off … and

• The price system is now giving the right scarcity signals.

Rich v. Poor

Suppose you have a bunch of people from Rochester Hills commuting down I-75 to downtown Detroit every day. Must be there by 8:30 am, so they plan to get there a little early. Some are “rich.” Others are “poor.”

Under a “come as you please” system, rich and poor come down randomly congestion between 7:30 – 8:30.

Suppose a poor person who values time at $0.20/minute ($12.00/hour) arrives at 8:15 and a rich person who values time at $0.40/minute ($24.00/hour) arrives at 7:15. Total waiting time costs are

Poor 0.25 hr. * $12 = $3.00Rich 1.25 hr. * $24 = $30.00Total Cost is $33.00

How about a time of day toll?

Doesn’t this discriminate against the poor?Doesn’t this discriminate against the poor?

Rich v. Poor

If you SWAP places you get:

Poor 1.25 hr. * $12 = $15.00

Rich 0.25 hr. * $24 = $ 6.00

Total Cost is $21.00! Savings of $12.00

Suppose you put on a $10.00 toll between 7:30 am and 9:30 am. Poor will travel earlier to avoid the toll and rich will probably travel later.

The rich would be (30 – 6) – 10 = $14 better off.

The poor would be (3 – 15) = $12 worse off.

The rich could compensate the poor, even after paying the toll. You could actually use the toll to compensate them. This is usually a suitable condition for Pareto Optimality.

How do you collect tolls?

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Have you ever been around Chicago?

Look at all the toll roads.

How do you collect tolls?

• They use the I-Pass.

• Could vary by time of day – I don’t think that it does.

• Could post it by time of day.

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