Short answer questions (references not needed)
a. Complete the following table of costs for a firm. (1 mark)
b. How much is total fixed cost at: (i) an output of 0? (ii) an output of 6?
How much is average fixed cost at: (i) an output of 5? (ii) an output of 10? (1 mark)
c. How much is total variable cost at an output of 5 and average variable cost at an output of 10? ( 1 mark)
d. Referring to the data from the above Table, draw the firm’s average and marginal cost curves. ( 2 marks)
e. Mark on the diagram the output at which diminishing returns set in. (1 mark)
a. Under what conditions will a competitive firm shutdown? Explain graphically. (2 marks)
b. Give an example of government-created monopoly. Is creating this monopoly necessarily bad public policy? (2 marks)
c. Why is a monopolist’s marginal revenue less than the price of its good? (2 marks)
d. Show the profit maximising level output and price of a monopoly. Draw appropriate graph to explain your answer. (2 marks)
a. Think of two products and estimate which is likely to have the higher price elasticity of demand. Explain your answer. (2 marks)
b. If a firm faces an elastic demand curve, why will it not necessarily be in the firm’s interests to produce more? (2 marks)
c.Two customers go to the fish counter at a supermarket to buy some cod. Neither looks at the price. Customer A orders 1 kilo of cod. Customer B orders $6 worth of cod. What is the price elasticity of demand of each of the two customers? (2 marks)
Essay question (references needed)
Question 4 ( 20 marks)
Coffee Prices: An unfair bean count?
The cultivating, processing and retailing of coffee is a big industry. Yet, the late 1990s and early 2000s marked something of a crisis for coffee producers. During this period the world supply of coffee rose relative to demand causing a slump in the price. The graph below shows the trend in the average price of coffee (there are many varieties and prices) between 1996 and 2011. Having reached $1.80 per lb in May 1997 (an imperial pound (lb) is equivalent to 454 grammes), it then fell more or less continuously over the next five years, reaching around $0.44 in 2002: a fall of some 75 per cent.
During this period, the supply of coffee increased by around 3.6 per cent a year, outstripping the 1.5 per cent annual increase in demand. The growth in supply was largely caused by new plantings in Vietnam and Brazil. In 2002 world demand was estimated to be around 106 million bags; but production was over 120 million bags with a further 40 million bags held in stock.
The effect of the low price on many coffee growers, who are mainly to be found in some of the world’s poorest countries, was catastrophic. Many farmers were driven into debt; others left the land and migrated to cities, worsening the often appalling conditions there. Others switched to growing narcotic drugs, such as coca in Vietnam.
As we can see from the chart, the price of coffee recovered after 2004, peaking in July 2008 at $1.33 per lb, its highest level since July 1997. In part, this was due to farmers diversifying into other crops; in part, it was due to buoyant global demand, with the emergence of new coffee markets, such as China and Russia, and strong demand in coffee-producing countries themselves.
In 2008, however, a combination of good harvests and a recovery in the coffee prices caused supply to increase substantially. Although demand was still growing in developing countries, the onset of recession in developed countries was halting the growth in demand and, as a result, the world growth in supply outstripped the world growth in demand. By the end of 2008 the price had fallen back to $1.03 per lb.
Coffee prices then soared in 2010, reaching over $2.30 by early 2011. These price rises were largely the result of poor harvests in central America and Vietnam and were then driven further upwards by speculation. But then with world growth stalling, and signs that the 2011/12 crop would be larger, coffee prices started falling again. But was this to be short-lived? Fears that heavy rains in Latin America would damage crops, and lead to prices rising again, drove coffee futures higher towards the end of 2011.
The retail price of coffee
You might be wondering why the price of a latte or an espresso in your favourite coffee shop did not follow the price received by coffee growers in the early and late 2000s. Well, of the price you pay for a cup of coffee only a very small part is accounted for by the coffee beans. The rest pays for the wages of staff, overheads, advertising and profits.
Fine, but why has the price of instant coffee in supermarkets not more closely followed the price of coffee? In particular, why did it not fall more noticeably during the ‘crisis years’ of the early 2000s? The answer here lies in the actions of coffee roasters. About a half of the world production of coffee is bought by just four huge companies – Kraft, Nestlé, P&G, and Sara Lee. These companies did not, in general, pass on the reduction in the price of coffee to producers but substantially increased their profits.
1. What do you think caused the large increase in the price of coffee in 1997?
2. Use supply and demand diagrams to explain (a) the fall in coffee prices in the late 1990s and early 2000s; (b) the increase in coffee prices from 2004 to 2011.
 The material in this case study has largely been drawn from the ICO website (www.ico.org).