Pearson Edexcel IAL Economics: Economies of scale, profit and shutdown points (YEC11) – Practice Questions

These are original questions written for Marlbridge, for revision and practice on this content. They are not reproduced past-paper questions, and they do not replicate the exam’s exact structure, question count or mark tariffs – examination boards hold copyright in their own papers. Use these alongside the official past papers from your board or school.

These questions follow 3.3.2 items 3 and 4 of the Pearson Edexcel International Advanced Subsidiary/Advanced Level in Economics (YEC11) specification, Issue 2, June 2018. They cover Unit 3, Business behaviour, which the specification labels an IAL compulsory unit (full International A Level only). All firms and figures are invented. Money is in currency units (cu). Read the study guide and the revision notes first, and use the course hub, the checklist and the free diagnostics.

Questions

1. A freelance photographer in Country C has an accounting profit of 14,000 cu in a year. She could have earned 16,000 cu as an employee. Explain whether she is earning normal profit and what she is likely to do. [3]

2. A tile maker in Country C has these long-run average costs (LRAC).

Output (thousand tiles a week)	5	10	15	20	25	30
LRAC (cu per tile)	14.00	11.20	9.80	9.10	9.10	9.80

(a) Calculate the percentage change in LRAC when output rises from 5 to 20 thousand tiles. [2] (b) State the minimum efficient scale and explain your answer. [2]

3. Market demand for tiles is 100 thousand a week at the going price.

(a) Calculate the largest number of firms that could each produce at the minimum efficient scale in question 2, and the number if new technology doubled that scale. [2] (b) Explain what the change implies for competition in the market. [2]

4. Name and explain the type of internal economy of scale shown in each case.

(i) A hospital group orders 5,000 pairs of gloves at once and pays 12% less per pair. [2] (ii) A fast-growing software company can now afford a full-time finance specialist. [2] (iii) A farm co-operative sells vegetables, dairy and eggs, so a poor vegetable harvest hurts it less. [2]

5. Twelve firms cluster in one town and a training college opens a course for their industry. Each firm’s LRAC falls by 6%.

(a) One firm’s LRAC at its minimum efficient scale was 9.10 cu. Calculate the new value. [2] (b) Explain whether this is a movement along the LRAC curve or a shift, and name the external economy. [3]

6. The possible links between n people in a call centre are n(n - 1)/2.

(a) Calculate the links for 8 staff and for 16 staff, and compare the increases. [3] (b) Explain how this and one other source of diseconomies of scale can raise LRAC. [3]

7. A phone repair shop sells 800 repairs a month at 15 cu. Total fixed cost is 6,000 cu (a lease it must pay either way) and average variable cost (AVC) is 12 cu.

(a) Show that it should keep trading rather than close in the short run. [3] (b) The price falls to 11 cu. Decide what it should do and justify your answer. [3]

8. A farm sells 25,000 kg at 8.40 cu. Explicit costs are 150,000 cu. The owner’s time and land could earn 50,000 cu elsewhere.

(a) Calculate accounting profit and supernormal profit. [2] (b) Explain the long-run effect on the industry if entry is free. [2]

9. A firm’s average cost falls from 10.00 cu to 8.00 cu as output doubles from 40,000 to 80,000 units. The price is 12.00 cu. Evaluate whether consumers will benefit. [8]

10. A small hotel in Country D sells 600 room-nights in the low season at 40 cu. Average variable cost is 34 cu and fixed costs are 24,000 cu a month (lease and loan payments).

(a) Calculate the monthly loss if it stays open and if it closes. [4] (b) Evaluate what it should do in the short run and in the long run. [6]

Answers

1. Normal profit is the least return that stops her switching to another job, an opportunity cost counted as a cost [1]. Economic profit = 14,000 - 16,000 = -2,000 cu [1]. She earns less than normal profit, so if this continues she is likely to take employment instead [1]. [3] Examiner insight: answers that subtract the opportunity cost and then state the consequence usually show more than a definition alone does.

2. (a) (9.10 - 14.00)/14.00 [1] = -35.0% [1]. [2] (b) The minimum efficient scale is 20 thousand tiles [1], the lowest output at which LRAC reaches its minimum of 9.10 [1]. [2] Examiner insight: the lowest output on the flat section is the one to give, since 25 gives the same cost but is not the first.

3. (a) 100/20 = 5 firms [1]. With MES 40: 100/40 = 2.5, so at most 2 firms [1]. [2] (b) A higher scale means fewer firms can reach the lowest cost [1]. Smaller firms have higher costs, so the market tends to become concentrated and entry is harder [1]. [2] Examiner insight: rounding 2.5 down to 2 and saying why shows you understand the idea of whole firms.

4. (i) Purchasing economy [1]: a bulk order earns a discount, lowering cost per unit [1]. [2] (ii) Managerial economy [1]: a specialist makes better decisions and the salary is spread over more output [1]. [2] (iii) Risk-bearing economy [1]: several products spread risk, so revenue is steadier [1]. [2] Examiner insight: a correct label with no reason linking to lower average cost usually earns only part of the credit.

5. (a) 9.10 x (1 - 0.06) [1] = 9.10 x 0.94 = 8.55 cu (8.554) [1]. [2] (b) It is a shift down of the LRAC curve [1] because growth of the industry, not of one firm’s output, lowers costs for every firm [1]. The external economy is the availability of skilled labour, as the college trains workers [1]. [3] Examiner insight: saying whose output has changed is the clearest way to separate a movement from a shift.

6. (a) 8 x 7/2 = 28 links [1]; 16 x 15/2 = 120 links [1]. Staff double but links rise 4.3 times (120/28 = 4.29) [1]. [3] (b) More links make messages slower or distorted, so decisions are late and errors costly [1]. X-inefficiency (or coordination): with weaker monitoring, waste is tolerated [1]. Total cost therefore rises faster than output, so LRAC rises [1]. [3] Examiner insight: ending the chain at higher average cost, not at a vague problem, is what links the cause to the curve.

7. (a) TR = 15 x 800 = 12,000; TC = 6,000 + 12 x 800 = 15,600 [1]. Loss if open = 12,000 - 15,600 = -3,600; loss if closed = -6,000 [1]. AR 15 exceeds AVC 12, and the contribution (15 - 12) x 800 = 2,400 covers part of fixed cost [1]. [3] (b) TR = 11 x 800 = 8,800, below total variable cost 12 x 800 = 9,600 [1], because AR 11 is below AVC 12 [1]. Opening loses 8,800 - 15,600 = -6,800, closing loses 6,000, so shut down [1]. [3] Examiner insight: comparing the two losses, not just stating the rule, shows the reasoning behind the decision.

8. (a) TR = 8.40 x 25,000 = 210,000; accounting profit = 210,000 - 150,000 = 60,000 cu [1]. Supernormal profit = 60,000 - 50,000 = 10,000 cu [1]. [2] (b) Supernormal profit attracts new firms [1]. Supply rises and price falls until AR equals AC and only normal profit remains [1]. [2] Examiner insight: the phrase “if entry is free” matters, so say how the answer would change if barriers existed.

9. Profit before = (12.00 - 10.00) x 40,000 = 80,000 cu [1]. If the price stays at 12.00, profit after = (12.00 - 8.00) x 80,000 = 320,000 cu, four times higher [1]. Cost falls 20.0%, so the firm could cut the price [1]. At a price of 10.00 consumers save 2.00 x 80,000 = 160,000 cu, and profit is still (10.00 - 8.00) x 80,000 = 160,000 cu [1]. Evaluation: the gain reaches consumers only if competition forces the price down; a firm with market power may keep it [1]. The result depends on the minimum efficient scale: if few firms can reach it, competition is weak [1]. Further growth could bring diseconomies and reverse the gain [1]. Higher profit could fund investment that benefits consumers later, though quality or choice may fall [1]. [8] Examiner insight: using the figures to compare two possible prices makes the evaluation specific and keeps it from being a list of generalities.

10. (a) TR = 40 x 600 = 24,000; total variable cost = 34 x 600 = 20,400; TC = 24,000 + 20,400 = 44,400 [1]. Loss if open = 24,000 - 44,400 = -20,400 cu [1]. Loss if closed = -24,000 cu (fixed costs) [1]. Contribution (40 - 34) x 600 = 3,600 is the difference [1]. [4] (b) Short run: AR 40 exceeds AVC 34, so staying open reduces the loss by 3,600 [1]. Staying open is stronger if the low season is temporary, since closing risks lost customers and the cost of rehiring [1], and the lease must be paid either way [1]. Long run: AC = 44,400/600 = 74.00, far above AR 40 even before normal profit [1]. If low-season prices persist the hotel should leave once commitments end [1], unless high-season profit makes the year as a whole profitable; so on balance it should stay open now but review the business over the full year [1]. [6] Examiner insight: a conclusion that separates the short-run and long-run decisions and rests on a calculated figure tends to read as a judgement rather than a summary.

Where marks are usually lost

• Treating accounting profit as supernormal profit without deducting the owner’s opportunity cost.
• Using average cost, not average variable cost, to decide on short-run shutdown.
• Stating a type of economy without explaining why average cost falls.
• Drawing or describing an external economy as a movement along the curve.
• Giving percentage changes with no working, or the wrong base.
• Forgetting that fixed costs are still paid if the firm closes in the short run.
• Writing a list of evaluation points with no judgement or no use of the data.
• Confusing diseconomies of scale with diminishing returns.

Next steps

• Check the formulas in the revision notes and rework weak questions.
• Reread the explanations in the study guide.
• Tick off outcomes on the checklist and see the course hub.
• Take the free 10-minute diagnostics.
• Book a free trial class.

Official syllabus

Pearson Edexcel International Advanced Subsidiary/Advanced Level in Economics, Specification, Issue 2, June 2018 (first teaching September 2018), published by Pearson Education Limited. Section 3.3.2, items 3 and 4, in Unit 3: Business behaviour.