ECONOMICS PROJECT

Past Paper 2002#7Past Paper 2002#7

By F.7A Shirley Chau (4)

Catherine Chau (5)

Wendy Fung (13)

Joanna Lai (18)

2002 # Question 7 Today in China about half of the state-owned

enterprises are persistently operating at a LOSS. Since the 1980’s, the government has closed some and privatized some by either selling out or issuing marketable shares against the capital values of the enterprises. In spite of these reforms, many state-owned enterprises still remain.

A) The state-owned enterprises have long been in existence. Why were they not losing money, or at least not losing as much, before economic reforms were introduced? Why have they started to lose more and more money as economic reforms progress?

B) Why has the government not privatized all state-owned enterprises even after twenty years of reforms? (10marks)

Before the economic reforms:Firms lose LESS money because:Monopoly competition can charge a higher

price ( market

power) $$$ (more revenue) Lose less

After the economic reforms: Firms lose MORE money because:1. Decrease in demand With the existence of private firms, competition competitive power as quality but price (private firms can lower the production cost by choosing the least cost method of production) customers shift to private firms with quality but price D $$ (revenue) Lose more

Increase in Transaction costWhat is transaction cost?All those costs that can’t

be conceived to exist in a Crusoe economy, they are not directly incurred in the physical process of product

After the economic reforms:

With the existence of private firmsless market power to set the price

cost to search the price

pricing cost competitive power promotion,

advertisement cost TR as TC

P

Q0

P1P2

Q1MR1 D1=AR1

MC

AC 1A

BLOSS 1

AC 2LOSS 2

P4C

Q2

P3 D

D2=AR2MR2

The case of state-owned enterprises

Summary:Before economic reforms:

After economic reforms:

<LOSS 1 LOSS 2

State-owned enterprises loss MORE after the economic reforms because of the decrease in demand and increase in transaction cost

Part B:Why has the government not

privatized all state-owned enterprises even after 20 years of reforms?

Why does the government keep on subsidizing the state-owned enterprises even though they’re suffering a loss?

Transaction cost? To privatize all state-owned enterprises,

transaction cost is involved E.g. Privatization involved some legal

processes, lawyers may have to be employed negotiation costs / contracting costs

Defining costs / delineating costs are also involved as government has to define the property rights by legal and social institutions.

Policing and enforcing costs are needed because they have to set law to ensure stable and quality production

Other Reasons~Some production can’t be privatized

because of reasons like:

Strategically,E.g. iron and steel industry,

weapon productionThese industries cannot be

privately owned as the government has to ensure its output and quality as well as the national security.

Socially,E.g. Power station

The government has to maintain stable and sufficient supply of energy for the interest of the society.

Politically,State-owned enterprises can provided

job opportunity for the citizens which can maintain political stability.

With smaller unemployment rate, people discontent is reduced, there may not be strikes and demonstrations.

Hence, the political situation remains stable.

~THE END~