Discuss the likely impact of ‘rising costs’ for coffee shops on their profitability

Edexcel A-Level Economics Paper 1 June 2022 Extract

Using a cost and revenue diagram, discuss the likely impact of ‘rising costs’ for coffee shops on their profitability (Extract A, line 2). (12 marks)

Rising costs is likely to reduce coffee shops’ profitability. Extract A mentions firms having to cover ‘rising wages’ and ‘rising rents’. Many of these costs would be incurred by firms at each level of output, particularly higher wages, so this can be represented on the diagram below. It shows an increase in average costs and marginal costs. This means that firms will choose to change their output from MC1 = MR to MC2 = MR as this is the new profit maximising level of output. The diagram also shows that the level of supernormal profit falls from the rectangle ABCD to the rectangle EFGH. 

However, rising costs could make it easier for some firms to increase their profitability. Extract A mentions firms like Costa ‘are continuing to lead coffee shop expansion’ despite the market conditions. Rising costs may cause some of the smaller firms in the coffee shop market to shut down, particularly if it means that the firms’ average costs exceed their average revenue in the long-run. This would allow the larger coffee shops to increase their market share. This means that their average revenue and marginal revenue would increase giving them more price-setting power, and greater supernormal profits despite higher costs.

A-Level Economics Tutoring

I offer one-to-one and small group A-Level Economics tutoring for students across the UK and internationally. With 87+ five-star Google reviews and tutoring experience since 2017, I specialise in helping students understand difficult concepts and improve their exam technique.