Fig. 1 shows the long-run average cost curve of a coffee-roasting business in a country where demand for premium coffee has grown. The firm began as a small...
Question 1 Report
Fig. 1 shows the long-run average cost curve of a coffee-roasting business in a country where demand for premium coffee has grown. The firm began as a small local producer but now supplies cafés, hotels and online customers. Its directors are deciding whether to build a second roasting plant. At low output, the firm gains lower unit costs as it expands. At a much higher scale, the curve rises because managing several sites may become difficult. The vertical line marks the minimum efficient scale, where the firm has its lowest average cost. This information may affect whether the market becomes dominated by a few largest firms.
(a) Define economies of scale in the context of this coffee firm. [2]
(b) Identify the output range in Fig. 1 where the firm has economies of scale. [2]
(c) Explain two internal economies of scale that may reduce the firm's average cost before it reaches MES. [4]
(d) Describe one diseconomy of scale that could increase average cost after MES. [3]
(e) Explain how substantial economies of scale can make an oligopoly market structure more likely. [4]
Answer Details
(a) Economies of scale mean a fall in average, or unit, cost as the coffee firm increases its scale of production. [2]
(b) They occur on the downward-sloping section of LRAC, from low output up to MES. [2]
(c) Technical economies may arise from a larger automated roaster processing more bags per hour, spreading machine cost over more output. Purchasing economies may arise when bulk buying beans or packaging lowers input prices per unit. Specialist managers or cheaper finance are also valid internal economies. [4]
(d) After MES, several sites may be difficult to coordinate. Messages can be delayed or distorted, and poorer monitoring may cause waste, duplicated work or inconsistent quality, raising average cost. [3]
(e) Large-scale firms have lower average costs and can charge lower prices while making profit. Smaller firms may be unable to match these prices, while high start-up costs deter entry. Consequently, only a few efficient large firms may remain, making oligopoly more likely. [4]
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