Thursday, 3 May 2012

What does Russel Norman know about economics?

From tv3 news
Russel Norman says higher power prices will hit the elderly.
Let us assume for the moment that Norman's statement is true, that is, power prices go up. What then to do? What is the most efficient way to deal with the problem? Is it to keep 100% of the shares in power companies in government hands? Or is it to adjust benefits for the elderly to take into account the higher power prices? The thing Norman needs to realise is that keeping companies in government hands and implicitly subsiding power prices - that is, getting prices wrong - isn't the efficient answer. Getting prices right and thereby allocating resources more efficiently and then using an income transfer is more likely to be efficient than getting prices wrong.
"It's certainly true… that power prices would go up under privatisation, which is what you'd expect, and if prices go up then some people will struggle to heat their homes – and that could result in some older people dying."

Opposition MPs say private shareholders demand profits and higher power prices are inevitable.
First of all the SOE Act says that SOEs basically have to act like any other firm. So if other firms can make profits so must SOEs. Thus there will be no difference between government and private ownership.

Second, profit is a residual, it is what is leftover from revenues after costs have been paid. Private shareholders can demand profits all they like, that doesn't mean they will get them. If they can just demand and get profits why not demand, and get, infinite profits?! To get profits firms have to produce and sell something that people want and are willing to buy and hope that the costs of production are lower than revenues. This give firms an incentive to keep the costs of production down. What shareholders can't do is just demand profits and have them appear as if by magic as Russel Norman seems to think. Profits come because firms are run as efficiently as possible. Notice that costs have to be paid today but revenues only turn up sometime in the future, so while firms may know their costs they don't know there revenues and thus profits (or losses) can be seen as a return to dealing with uncertainty. Also if revenues are uncertain its not clear how shareholder can demand a given level of profit.

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