2022 Paper 1 Flashcards
With reference to Figure 2 and your understanding of price elasticity, examine two factors that may cause significant changes in the international price of coffee beans. (8)
The data shows a significant price increase from 3.85% in Jully 2022 to (+11.11%) in August 2020 This suggests a potential supply disruption, which could have been due to bad weather conditions, such as droughts. Bad weather decreases the supply of coffee beans as it restricts production. So the supply of coffee beans is limited and becomes more inelastic in the short term because coffee producers cannot grow more coffee beans quickly. So small changes in supply can lead to large price increases.
Coffee demand is also price inelastic, as it is a habitual good. As incomes rise, this leads to higher demand for coffee. In March 2020, the price of coffee rose by 9.6%, partly due to increased demand. Since consumers are relatively unresponsive to price changes, any increase in demand due to higher incomes can push prices up significantly.
However the presence of buffer stocks can smooth out price changes reducing volatility in the long run
Profit maximisation is assumed to be the business objective of most firms. With reference to Extract A, assess whether this is the case for coffee shop owners. (10)
-Profit maximisation is when firms produce at the point MC=MR
-Draw profit max diagram
-Coffee shops can be considered to be operating at MR=MC as Coca-Cola company stated aims “maximising long term returns to shareholders” therefore this suggests that the objective of Coca-Cola is for costa to maximise its profits leading to an increase in the return to shareholders in the form of dividends, suggesting that the branded names seek to maximise profits.
-However when the branded firms are under threat of increased competition within the market which can be seen in “remain a threat to branded shops” therefore this suggests that within the coffee shop market, there are relatively low barriers to entry, therefore leading to hit and run competition for the branded incumbent firms, therefore there will be little incentive for firms to profit maximise, so they may decide to sales maximise at AC=AR,therefore reducing supernormal profits
-Another reason why it can be assumed that coffee shops are not all profit maximisers is that small coffee shops run on average profit as low as 2%, therefore suggesting large supernormal profits are not made by all coffee shops
-However the coffee shops are also operating within a niche market “unique experience” therefore they may not need to lower their prices in order to remain competitive due to greater brand loyalty that the other chains,therefore suggesting that firms with stronger brand loyalty will be profit maximisers.
< same but short
Pmax= MC=MR a firm may want ot maximise profits to expand to ensure shareholders getting dividends = can use profits to expand and grow and make profits in LR
EVAL: principle agent problem=objectives of shareholders(principles) which is to maximise profits might not be shared with objectives of agents (managers) as managers salary not linked with profits generated = may want to profit satisfise instead as less incentive to pmax and salaries not linked to profits so may just want to earn enough to just make shareholders happy
Using a cost and revenue diagram, discuss the likely impact of ‘rising costs’ for coffee shops on their profitability (Extract A, line 2). (12)
Profitability is the difference between total revenue and total costs
Increase in advertising/rent/wages (Fixed Cost) shifts AC upwards
• Increase in price of coffee beans/wages (Variable Cost) shifts AC and MC upwards
AC snd MC shift UP
An increase in costs of production will likely lead to decreased profitability.Wages rose by 6.2% and there were “rising rents”.This increase in the cost of labour and land mean that average costs and marginal costs rise. Ceterus paribus this should lead to lower profits.
However, Ped for coffee is relatively inelastic as coffee is a necessity for many and takes up a small percentage of their income.This means that coffee producers can lay the majority of the burden of higher costs on consumers and therefore will lose less profits
Also national minimum wage increased by 6.2% for over 25s increase variable costs. However only applies to people above 25 so firms may switch to younger workers so costs wont increase as much also if workers get higher wages they may see increased productivity as opportunity cost of losing your job is greater so costs may actually fall
Costa coffee opened 60% fewer stores in 2019 than in 2018.With fewer stores opening this means the ability of these firms to make widescale profits is greatly reduced and stores may close down leading to lower profits
However, one effect could be that independent coffee shops that are failing to make a profit may leave the market therefore leading to lower demand for labour and a decrease in wage costs. Therefore long term profitability for brands like costs may not be affected
With reference to the information provided, discuss whether the coffee shop market is contestable (15)
A contestable market has low barriers to entry and exit, allowing firms to enter and leave easily [K]. The coffee shop market appears contestable due to low start-up costs, as renting shop space and coffee machines is relatively inexpensive [Ap]. Greggs’ entry into the market by simply adding seating and expanding its menu (Extract B) supports this view, as it suggests that firms can compete without major investment [Ap]. The increasing competition from independent coffee shops also indicates new entrants can establish themselves, making the market more contestable
However, the market is not fully contestable due to high barriers to entry. The industry is highly concentrated, with three major firms holding nearly 53% of the market, giving them strong brand loyalty and economies of scale [E]. These firms have significant resources for advertising and promotions, which independent coffee shops struggle to match [E].
Another sign of contestability is the low sunk costs involved in training staff [K]. Unlike industries requiring high R&D investment, coffee chains only need to train baristas, which is relatively inexpensive [Ap].
This lowers the risk of entering the market, making it easier for new firms to challenge established brands [An]. The Coca-Cola takeover of Costa (Extract A) also suggests that major brands see growth opportunities, which could encourage further new entrants
However, some firms face high rent costs, especially in prime locations, making it difficult for smaller independents to compete [E].
Additionally, large chains benefit from collusion and economies of scale, allowing them to keep costs lower than smaller entrants [E].
These factors reduce the extent of contestability, as many smaller firms struggle to survive despite low entry costs [E].
Tesla held an 82% market share of the electric vehicle market in the United States during the first half of 2020. Evaluate whether a monopoly is likely to operate efficiently. Refer to at least one monopoly of your choice.
(25)
One argument in favour of monopoly efficiency is productive efficiency [K]. If a monopoly benefits from significant economies of scale, it can lower long-run average costs (LRAC) as output increases, as shown in the diagram where costs fall until the minimum efficient scale (MES) at point A [An]. Tesla, for example, benefits from purchasing economies of scale by negotiating lower battery costs due to bulk orders [Ap]. Similarly, technical economies arise from large-scale automated production in Tesla’s Gigafactories, reducing per-unit costs [An]. If a monopoly can maintain production at MES, it can achieve productive efficiency [An].
However, monopolies are often associated with X-inefficiency due to a lack of competitive pressure [E]. Without rivals, firms may have organisational slack, leading to unnecessarily high average costs [E].
In Tesla’s case, inefficiencies such as production delays and supply chain issues indicate that even firms with high market share may fail to minimise costs [Ap]. As the diagram shows, a firm operating above the MES incurs unnecessarily high costs, reducing productive efficiency [E].
Tesla’s pricing strategy also highlights allocative and productive inefficiency [K]. The second diagram shows that a monopoly price Pl is not productively efficient as output is at point a, rather than the lowest point of the AC curve at b [An]. This means the firm is not minimising costs and is operating with excess inefficiency.
Additionally, the monopoly price Pl is not allocatively efficient, as price is not equal to MC at point c, leading to a deadweight welfare loss [An]. Tesla’s high prices limit accessibility to electric vehicles, preventing some consumers from benefiting from the technology [Ap]. This results in a misallocation of resources, where fewer cars are sold than in a competitive market
However, the degree of inefficiency depends on the contestability of the market [E], If new firms ent and provide alternative electric vehicles at lower prices, Tesla may be forced to reduce prices or improve service quality to remain competitive [E]. Additionally, government intervention in the form of subsidies for electric vehicle purchases may offset some of the negative welfare effects by making EVs more affordable
If a monopoly benefits from economies of scale and reinvests profits into innovation, then it may achieve productive and dynamic efficiency. However, if it faces little competition and does not reinvest, then X-inefficiency and allocative inefficiency may dominate. If regulators intervene to cap monopoly pricing or promote contestability, then efficiency levels could improve. The extent to which monopolies operate efficiently depends on their incentives to minimise costs, reinvest profits, and respond to market forces.
