Tutorial 7 Industry Application Questions 2017 PDF

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Tutorial 7 – Industry Application QuestionsNote: for water supply industry, think of Sth Aust situation only in all industry applied questions Draw a diagram (not copy & paste; you need to draw and label it) showing AVC, ATC and MC for the short run for firms in your industry. No need to inc...

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Tutorial 7 – Industry Application Questions Note: for water supply industry, think of Sth Aust situation only in all industry applied questions

1. Draw a diagram (not copy & paste; you need to draw and label it) showing AVC, ATC and MC for the short run for firms in your industry. No need to include AFC. Explain the shapes of these curves - what economic principle is behind their shapes? Explain where the MC cuts the AVC and ATC curves. (use your own words to demonstrate your understanding of these principles) 6 marks The AVC curve is a ‘u-shape’ curve, which is because of we additionally add more units of labour and then as outputs increase and income increases we will see a fall in these costs. This AVC starts off with a relatively high unit cost; knowing that AVC incorporates the additional labour units added to production, the more labour added as output increases will ultimately provide better productivity; however, this curve is affected by the law of diminishing return. This law states that the more input of labour through increasing outputs can eventually decrease productivity and increase costs, this only being if the capital is fixed. For the ATC, again ‘u-shaped’ for the same reason, this will be a higher cost and further up on the graph than the AVC and AFC. As the AVC and AFC equal to the ATC, they will both influence the shape of the curve. The AFC will continue to remain relatively stable throughout the increased output, as the costs are fixed. The AVC will increase with additional labour units, therefore increasing the ATC; this having a more substantial affect than the AFC. The ATC will be affected by the law of diminishing return, but only through the AVC. The MC is a bootleg shaped curve and on the other hand will at first have a small decrease in costs, as the difference between the total cost and product will be relatively small, but as the product output increases and the variable costs increase, the marginal cost will continue to rise. This curve will meet the minimum points of the AVC and ATC curves, as when the MC curve, is below these curves it will be below average bringing the average down; however, when the MC curve rises above the curves this is ultimately raising the average of both curves. When the curves meet each other, this means that the average is the same and will not be moved at that unit cost.

2. If firms in your industry thought that demand was going to increase in the future by a significant amount – say, by 50% or more – they would need to change the scale of their operation. Briefly explain which of the resource inputs to their production process would probably take the longest to change, to be able to increase production by such a large amount? (please name a specific input, not the category of input type). Therefore, explain how long you think the short run would be likely to be for your industry? 2 marks

A café shop’s focus would be on sales increase in their coffee products. As most coffee products have already been set as a cultural product, with many menu’s offering the same, an increase would need to come in ranges such as teas, chocolate or chai hot/cold drinks. If demand was increasing at a certain point in time, a short run decision would have to be made around whether the inputs that will be added will be beneficial in the short run and whether the outputs created from this extra input would be productive. In the case of café’s and coffee shops, the main input that would take the longest to change is an increase in the size or capital within a coffee shop. To meet customer demands, a café will have to increase its guest count capacity and if a small café’ is expecting its increase of over 50%, the equipment and building size may be an issue for some. This input requires planning, approval, time and investment and can take anywhere from a couple of months to a year. This short run decision may take a few months for new equipment to arrive or up to ¾ of a year for any building work/renovation to take place.

3. Are economies of scale important to the firms in your industry? Explain why, or why not. Give two examples of economies of scale in your industry. 4 marks Economies of scale is the balance between marginal costs and output. A successful economy of scale will show that as output increases within the firm, marginal costs are lowering leading to a profitable business with a higher profit margin. Labour within this industry is extremely intensive, with every capital dollar spent = $15.73 spent on wages (IbisWorld Industry Report, 2016) output in a coffee shop is very quick in production and expends a lot of coffees/products in a short amount of time, showing a stable income. It is important that this type of industry does not fall into a diseconomy of scale as this would mean that the additional inputs of labour are not creating anymore outputs. In the café’ industry, many owners/operators tend to lease equipment’s or buildings, enabling lower fixed costs, this would weigh out the cost of labour and other fixed costs to ensure that the marginal cost would be at a rate of profit. Bulk buying would be another example of economies of scale within the café industry – as coffee and milk will be bought in such large quantities, reduced and smaller prices on these items may be agreed to by vendor and seller. This will allow for the variable costs of the business to be reduced by a fraction leading to a smaller ATC. This would mean that the marginal cost would be at a steady rate and not increasing dramatically.

4. Are diseconomies of scale possible in your industry? Explain. Give an example of a diseconomy of scale for a firm in your industry. 3 marks Diseconomies of scale can take place within this industry, however are probably seen in smaller type café’s where fixed and variable costs can increase and output is still volatile and staying relatively low. This can happen when input costs increase, such as food, beverage or lease costs. If these costs increase, the output will not increase as there is no additional labour or capital being added, yet prices are still rising. This will see a decrease in marginal profit and would see an economic loss. The increase cost of inputs can see a need for short run decisions such as

redundancy, reducing additional inputs and equipment downgrades. These short run decisions can ultimately save the business in the long run, which will hopefully see them come back around.

5. Draw a long run cost curve for firms in your industry and explain its shape. 2 marks Students should draw their own graph (NOT copy & paste) no need for numbers – this is a conceptual question

The long run cost curve consists of economies of scale, constant returns of scale and diseconomies of scale. Economies of scale is when the average total cost falls as the output increases with plant size and capital growth, after a certain point, output then becomes a constant return of scale, where the returns on the extra output is at the same cost as the ATC, when the output becomes too high and there is no extra revenue from this output, the curve goes upwards and creates a diseconomies of scale, where the cost of creating extra outputs is costing more than the ATC....