This is a solution of the questions given case study for Managerial Economics Assignment.
Answer to Q-1
Jim McIlroy (2014), in his article “Gov’t moves to sell Medibank Private”, comments on the news about government’s move to sell Medibank Private, a state-owned health insurer. The article mainly talks about the negative side of privatization of government enterprise by citing the reactions of various renowned personalities of the country. The author has, intentionally or unintentionally, not looked into the positive side of the story.
The article starts with giving the details of the move like the objectives behind the privatization, the process that will be followed and the government’s plan to use the proceeds from the sale of Medibank Private. The author criticizes the theory of privatization of profit making state-owned organizations stating that it is actually theft of public assets. The author also argues that the asset recycling pool will transfer the public assets from one form to another which will result in overall loss to the public as the government will not earn profit from the Medibank Private.
The article, then, talks about the history of privatization in Australia which dates back to 1990s under the leadership of Hawke-Keating. Since then, each and every government has pursuit the privatization policy. The author provides further details of the government’s plan like the shareholding patterns and expected price of the stocks. The author then provides the figures of profits made by Medibank in last four years proving his point further that the profit making government enterprises should not be privatized.
The rest of the article cites the opposition of the government’s move by various renowned personalities and supporting the arguments by adding the author’s personal views and details. The important messages of the author on the negative side of the government’s move are summarized below:
- The move will impact around 4000 staff members and 3.8 million customers of the company. This is a standard response of all the critics of privatization in general.
- The privatization of state-owned insurer would lead to increase in price-levels of health care industry as it is the market leader and private companies always focus on profit maximization.
- The government will suffer in terms of revenues as the contribution of Medibank was quite significant.
- The author dwells into the history of Medibank by citing that the sole aim of Medibank at the time of its establishment was to provide health insurance to public at affordable prices. By privatization, the sole aim of the state enterprise will be lost.
- By following creeping privatization, Australia will end up having worst health care system like the ones in USA and UK.
- The unions and public at large will wage war against the government’s move.
In between, the article cites the Socialist Alliance’s vision for Australian Health Care System. The Socialist Alliance offers a totally different and radical Health Charter which states that there is no need of Private Health Insurance at all. The system should rather focus on providing health facilities at cheaper rates. The plan of Socialist Alliance states that all the subsidies given by the Government to the health insurance industry should be stopped and the resulting funds should be utilized in betterment of health care system as in hospitals and other facilities.
Overall, the author criticizes the government’s plan to privatize the Medibank by providing some tough and strong arguments. However, the articles lack the credibility as it does not mention any positive side of the planned move.
Answer to Q-2
Before answering the specific question, let us understand some of the terms involved in the question. Every firm has its own economic objective to be achieved. The private firms normally have the objective to maximize the profit, while the government or NGOs normally have the objective to maximize the welfare of the society or economy. The welfare is maximized when all the stakeholders gets the maximum possible benefit without decreasing other stakeholders’ benefit (Hicks, 1939). This is possible when the total surplus is maximized. Total surplus is the sum total of consumer surplus and producer surplus. Consumer surplus is the difference between the price consumers are willing to pay and the actual price. Producer surplus is the difference between the actual selling price and the price at which the producers are willing to sell their product.
As discussed above, to maximize the welfare, a firm has to maximize the total surplus. This is possible when the price is equal to marginal cost of the product. As depicted in the below diagram, when the price is set equal to marginal cost i.e. the point where the demand (price) curve meets the supply (MC) curve meets.
Therefore, Medibank should set the price equal to the marginal cost of the product it is offering to achieve its objective of maximizing the welfare of the society.
At this price (P*) and quantity (Q*), the consumer surplus if the area A in the above diagram and the producer surplus is the area B. The total surplus is the area A+B. any change in the price from this point will reduce the total surplus and thus Medibank will not be able to achieve its objective of maximizing welfare (Negishi, 1960).
Now, let us analyze the situation when the government imposes a buyer’s tax on the products of Medibank. Medibank’s has a price that maximizes welfare. At this price, the consumer and producer surplus are maximum. The extra burden of specific buyer’s tax will be shared by both i.e. consumer and producer. As a result, the price will increase but not exactly equal to the amount of buyer’s tax but less than the amount of buyer’s tax. However, as depicted in the graph, the consumers will end up paying higher price (Pc) and the producers will end up getting less amount of revenue (Pp). The difference between these two (Pc and Pp) will be the revenue generated by the government on sale of every unit of the product of Medibank.
Thus, both the consumer surplus and producer surplus will decrease. Resultantly, the total surplus will also decrease and the decrease in the total surplus will be equal to the revenue generated by the government through this specific buyer’s tax. In the graph below, the area shown in blue color is consumer surplus, the areas shown in yellow color is the producer surplus and the area shown in green color is the revenue generated by the government through buyer’s tax.
Answer to Q-3
There are difference types of markets in economy and based on the characteristics of the markets. Pricing is done by the firms. The pricing strategies are different for perfectly competitive market, monopolistic market, monopolistic competitive market, etc. (Machovec, 2002). We have a situation where the Medibank is privatized and it has a monopoly power. In a monopoly, the market has only one seller and many buyers. So, in such cases the seller has the power to set the price on its own terms. As the buyers do not have any other option, they have to accept the terms of the seller (McAfee, McMillan & Whinston, 1989).
As the objective of the Medibank is to maximize the profit, it will set the price where it can get the maximum profit. In a monopoly, the profit is maximized when the price is set at a point where the marginal revenue is equal to marginal cost of the product. Marginal revenue is the additional revenue generated by the sale of one additional unit of the product. Similarly, marginal cost is the additional cost incurred by the firm by the sale of one additional unit of the product. When the marginal cost and marginal revenue becomes equal, the firm does not have any profit selling products after that level of sale as it does not earn any profit after that point.
Thus, as depicted in the graph below, the Medibank should set the price Pp to maximize the profit of the firm. At this level, the marginal revenue and marginal cost curves are intersecting i.e. MC=MR. The level of output is Qp at this point.
Now, if the objective changes from maximizing profit to maximizing revenue, the pricing policy changes. Now, the firm has to search for a price where there is no additional revenue by selling one additional unit of the product. This will be the point where the marginal revenue is zero (Berg & Tschirhart, 1989). As depicted in the graph, at the price Pr, the marginal revenue is zero. The level of output at this point is Qr.
Thus, the pricing policy depends on the type of the market the firm is operating in and the objectives of the firm.
Answer to Q-4
Privatization is a concept where the government sells state-owned businesses to the general public. Generally, the privatization is carried out with an aim to bring efficiency and effectiveness in the business and reduce the administrative burden on the government (Tilson & Zheng, 2014).
The Australian government announced the plans to privatize the Medibank Private to retail and institutional investors by offering IPO. The company got listed on Australian Stock Exchange and got sold with 100% holding to the general public marking, a complete privatization. It was a bold move from the government despite the strong opposition.
The reasons for privatization of Medibank given by the government are:
- Medibank being a “for profit” enterprise, the government could not find compelling reasons to own it.
- There is a conflict of interest as the government is the regulator of the market as well as the key and most important participant of the market.
- The proceeds generated through sale will be useful to invest in significant productivity enhancing infrastructure.
Apart from this, there is also a reason behind the privatization that is not articulated by the government. The ruling Abbott government made it an election agenda by promising the privatization of Medibank during the last election. Apart from this, the structure was health-care system was very much complicated. Medibank was a state-owned enterprise; the government earned the profits as it was no more a ‘no for profit’ organization; the government also regulated the health insurer market; the government also provided subsidies to the market; Medibank was also paying taxes as per the taxation rules. Thus, privatization did make the structure of the health care system a bit simple. However, “has it been good or bad for the country?” is the point of discussion and nobody has the clear and convincing answer yet.
To answer the question on what is superior: market-based health care system or government-based health care system, we have to look at the degree of the product as a necessity. Generally, the governments administrate the businesses of products which are necessities to the general public. For example, almost all the countries and economies administrate the distribution of water, electricity and other necessary products. The governments usually do not privatize these kinds of services. So, we have to discuss whether the health care system is a necessity or it is a luxury.
It is widely accepted fact that strong health care system is a responsibility of the government towards the people of the country. Health care system is of paramount importance to the well-being of a nation. In such circumstances and with growing problems and issues in health-care, there is no doubt that health care has become a necessity. So, it is a responsibility of the government to provide health care system to the general public at affordable prices. In market-based health care system, it is not possible to control the pricing of the products. However, there are instances of privatization where the market-based economies have proved to be more affordable due to increased efficiency and competition in the market. So, as long as the government is confident of this thing happening, it becomes irrelevant whether the health care system is market-based or government-based. But, at this point of time, the health care market does not seem to be competitive enough to make health care affordable to the public. Also, taking into consideration the strong opposition of the privatization, even the public at large is also not confident of the government move.
Thus, it is difficult to say which system is superior for health-care, but there is no doubt that the health care should be affordable for the general public irrespective of the system adopted by the country.
Answer to Q-5
Health care policies adopted by different countries are different in many ways. We will analyze and compare the health care policies of United States and Japan. The health care system in both these countries is totally different. The United States follows a free market health care system, whereas the Japan follows the structure of government controlled structure of health care industry (Cooper & Taylor, 1994). In the United States, the government does not have direct interference in the market by way of price regulation or any other kind of mechanism. In Japan, the government regulates each and every aspect of health care considering health care as a basic right of the people of the country.
In the free market policy followed by the United States, the richer gets better facilities with high quality medical insurance, while the poor has to compromise on the health care facilities. There are many who rate United Health Care system as the worst among the industrialized countries (Cooper & Taylor, 1994). The Japan offer a completely different mechanism where the health care services is the basic right of the people of the country and everyone has the access to same quality of services irrespective of their income, age group, etc. The prices are set by the government processes and the physicians charge the patients equally as per the rules and rates designed by the government. The Japan’s model of health care system has gained appreciation from various countries and many economies are following the steps of Japanese health care system.
As far as Australia is concerned, the government followed a mixture of free-market and government controlled policies till it privatized the Medibank. The privatization marked the complete free-market system of health care in Australia.
As discussed in the previous question, the health care has become a basic necessity due to increasing concerns over the health issues faced by the people. In such circumstances, the policies followed by the countries like Japan is the need of the hour. Australian government should have not carried out the privatization of Medibank. It is difficult to find compelling reasons to privatize a profit making health insurer which was also offering services at quite affordable rate and enabling the government to control the health care system as the Medibank Private is the market leader.
We have seen that the free-market in health care has not proved to be effective as there are many examples of failure of health care system with United States leading the table. On the contrary, government based health care systems have survived the test of time and are increasingly becoming the most reliable. However, the success of government based health care system depends on the efficiency of the government and this is a point which can not be ignored before adopting government based health care systems.
- McIlroy, J. 2014, Gov’t moves to sell Medibank Private.
- Tilson, V, & Zheng, X. 2014. Monopoly production and pricing of finitely durable goods with strategic consumers׳ fluctuating willingness to pay, International Journal of Production Economics, 154,
- Berg, S. V. & Tschirhart, J. 1989, Natural monopoly regulation, Cambridge Books.
- McAfee, R. P., McMillan, J. & Whinston, M. D. 1989, Multiproduct monopoly, commodity bundling, and correlation of values. The Quarterly Journal of Economics, 371-382.
- Machovec, F. 2002, Perfect competition and the transformation of economics, Routledge.
- Negishi, T. 1960, Welfare economics and existence of an equilibrium for a competitive economy, Metroeconomica, 12(2‐3), 92-97.
- Hicks, J. R. 1939, The foundations of welfare economics, The Economic Journal, 696-712.
- Cooper, E. & Taylor, L. 1994, Comparing Health Care Systems: What makes sense for the US?, Context Institute.