Revenues, Costs & Profits (Edexcel A Level Economics A): Exam Questions

In 2016, the insurance group Esure undertook a demerger with its GoCompare price comparison website.

Following the demerger, GoCompare announced in 2017 a profit of £17.5 million, up 21.5% on 2016. Total revenue in 2017 was £75.8 million, up 4.1% on 2016.

(Source: adapted from https://www.insuranceage.co.uk)

Emily owns and operates a nail ink salon. The diagram shows the cost and revenue curves for treatments at her nail ink salon. Initially, Emily sets her price to maximise profits.

In 2015 JCB, the construction equipment manufacturer, experienced a 6% fall in revenue. This resulted from a reduction in sales of construction equipment to emerging markets.

Figure 2: The monthly rental cost of a telephone landline

Extract B

BT profit rises

BT Group, which includes BT Openreach and BT Retail, reported a rise in profit as revenue increased following the integration of the consumer mobile business, EE. BT finalised the takeover of EE in August 2016, and the integration has resulted in BT controlling 35% of the mobile consumer market. The profit of the UK-based telecommunication group in its second quarter 2017 rose to £566 million.

BT Group chief executive Gavin Patterson said: “We will operate a multi-brand strategy with UK customers being able to choose a mix of BT, EE or Plusnet services, depending on which suits them best. The acquisition enables us to offer great value bundles of services and customers are set to be the winners as we compete for their business”. 

(Source: adapted from www.marketwatch.com (Oct 27 – 2016) and http://home.bt.com/ news/bt-life/bt-to-retain-ee-brand-as-acquisition-confirmed-11364037422234)

Extract C

BT to slash landline charges for 1 million customers

Rental charges for landline-only customers – households with a telephone-only contract but no BT broadband – will fall from £18.99 to £11.99 per month after the regulator attacked existing deals as ‘poor value for money’. This rental reduction will save a million landline-only customers £84 a year. 

The regulator Ofcom (Office of Communications) said it stepped in because these bills for landline-only customers – nearly two-thirds of whom are over 65 – have “soared” in recent years. This is despite BT and other landline providers benefiting from significant cuts in the wholesale line rental cost of providing the service by BT Openreach. Many landline-only customers are elderly, and have been with BT for decades. Ofcom has focused on BT because it accounts for two-thirds of the UK’s 1.5m landline-only customers.

A spokesperson for Ofcom said “This position [of dominance] has allowed BT to increase prices without much risk of losing customers, and other providers have followed BT’s pricing lead. We expect BT’s price cut to mean other providers will follow suit”. Ofcom said that over three-quarters of BT’s landline-only customers have never switched provider, which has left them a prime target for price rises. The regulator said that all major landline providers have increased their line rental charges by between 23% and 47% in recent years, while their own costs for providing the service have fallen about 27%. Ofcom said it is also looking at measures to help people shop around for better deals with more confidence.

(Source: adapted from https://www.theguardian.com/business/2017/oct/26/bt-to-slash-landline-charges-for-1m-customers)

Extract D

The end of the High Street?

Homebase, the UK’s second-largest do-it-yourself (DIY) retailer, made £20–40 million a year in profit up to 2016. The Australian conglomerate Wesfarmers bought Homebase for £340 million in 2016 and began to rebrand 24 stores under its own name. It scaled back on curtain, cushion, and other homeware sales in favour of power tools and building materials. In 2018, Wesfarmers sold the DIY chain for £1, in the face of “extremely challenging” market conditions and excess store space. The chain was bought by restructuring specialist Hilco, which had also rescued the music chain HMV in 2013, and the stores have gone back to using the Homebase name. Over 70% of Homebase stores are currently losing money, and the new owner wants to exit loss‑making stores and agree to rent reductions, as sales fell 10% in 2018. Homebase has gone back to popular products and brands dropped by its previous owner, Wesfarmers.

The closures will add to the mounting job losses on Britain’s high streets. About 25,000 jobs have gone in the first seven months of 2018, according to analysis by an economics think tank. A further 8,300 jobs are under threat at suppliers, with the multiplier effect meaning that GDP is £1.5 billion less than projected.

Several Marks & Spencer clothing stores closed their doors for the last time as the high-street chain pushes ahead with a transformation plan. It plans to close 100 stores by 2022. Toys R Us, Poundworld, and Maplin have shut down completely, while New Look, Mothercare, and Carpetright have plans to close hundreds of stores as losses rise sharply. Increasing rents and higher business rates have occurred at the same time as falling consumer confidence. Meanwhile, House of Fraser employees and pensioners are nervously awaiting more details about their future. The £90 million rescue deal by Sports Direct, the sportswear chain controlled by Mike Ashley, will protect 16 000 jobs for the time being.

(Source adapted from: https://www.ft.com)

Extract C

The National Living Wage (NLW)

The Government has announced that from 2016 it will introduce a Living Wage Premium that will apply on top of the National Minimum Wage (NMW) for employees aged 25 and over to deliver a National Living Wage (NLW) for those people. The main NMW will continue to be set for all employees aged 21 and over, so that those aged 21 to 24 will continue to be subject only to that rate.

The effective minimum wage for the 25+ age group will therefore be over 13% higher in 2020 than would otherwise have been the case, and result in a 0.3% increase in wage costs overall. Further impacts on real GDP are estimated to be higher productivity (+0.3%) but lower average hours worked (-0.2%) and higher unemployment. Overall real GDP is forecast to fall by 0.1% as a result of the NLW. However these forecasts depend on estimates of the likely elasticity of demand for labour.

Academic evidence suggests that changes to the NMW since 1999 have led to only limited effects on demand for labour in the UK. The types of work that will be affected are relatively labour intensive, which may limit the scope for firms to substitute towards using capital. Firms may also be expected to shift demand in favour of the under-25s given that they will not be subject to the NLW, which all else being equal would lead to a smaller reduction in overall labour demand. Some of the reduction in employees could also be partially offset by a rise in self-employment. But increasing the NLW to a higher proportion of median earnings may lead to bigger effects than have been experienced in the past.

(Sources: adapted from http://cdn.budgetresponsibility.independent.gov.uk/ July-2015-EFO-234224.pdf and http://budgetresponsibility.independent.gov.uk/)

Extract E

Indonesia’s economic policies as commodity prices collapse

Indonesia is the world’s fourth largest exporter of coal, and the raw material accounts for 11% of its exports. Its other main exports are crude oil, palm oil, rubber, and tin. Its main commodity exports tripled in value between 2000 and 2010, and as exports boomed, so did the economy. But the value of commodity exports has fallen by more than half from its peak. Coal now sells for just US$50 per tonne, against US$125 in 2011.

In the decade to 2014, Indonesia’s real GDP grew by an annual average of 6%, but the collapse in commodity prices has slowed the economy. In 2015 growth was 4.8%, the slowest rate since 2009. But compared with many other commodity exporters, Indonesia is getting off lightly. 

The value of the rupiah, Indonesia’s currency, against the US dollar has fallen by 30% since 2013 but has since stabilised. Other emerging market currencies have depreciated even more steeply over that period. Despite the weak exchange rate, Indonesia’s inflation rate has mostly remained within the central bank’s target range of 3-5%. The main impact of the rupiah’s fall has been to curb imports, helping limit Indonesia’s current account deficit to around 2% of GDP despite weaker export earnings. A cautious fiscal policy during the boom years has allowed for a modest fiscal expansion to offset the effects of weak exports and investment. The national debt is just 26% of GDP.

Mr Widodo knows that Indonesia cannot raise its long-term growth rate if the economy remains reliant on coal. It needs a broader range of manufacturing and service industries. 

If new enterprise is to flourish, Indonesia must support local entrepreneurship. The labour market is inflexible. To start a business takes an average of 47 days, compared with four in Malaysia and two in Singapore. The President’s supply-side policies are improving the business climate. The average number of days needed to approve a new power plant has declined from 900 to 200. The government recently revised its “negative investment list” of sectors in which foreign ownership is banned or restricted, fully opening up the rubber, film, and restaurant sectors, among others. In 2015 he launched a series of measures to try to reduce government failure, including easing some regulations, streamlining licensing procedures for firms on industrial estates, and providing tax incentives to invest in special economic zones.

The government has used savings from cutting fuel subsidies, worth over 4% of GDP, to fund extra capital spending. But the budget deficit still widened to 2.8% of GDP, very close to the legal limit of 3%. If public expenditure is to increase further, the government will need to raise more revenue. That will not be easy. Most workers and employers pay little or no tax. Only 27 million of Indonesia’s 255 million people are registered taxpayers, and in 2014 just 900,000 of them paid what they owed, leaving it with a tax revenue to GDP ratio of around 10%. Big companies say that they are being squeezed harder by the tax authorities because they are an easier target.

Infrastructure spending will help bring foreign investment and good jobs to Indonesia as well as encourage exports. Indonesia’s infrastructure problem can be summed up as too few roads and congested ports. In the short term, infrastructure spending puts people to work and boosts demand for raw materials. In the longer term, this spending offers the chance to make up for decades of neglect and underinvestment. Indonesia has plans for 65 dams, 16 of which are already under construction. In 2015 work started on the Keureuto Dam, designed to boost agricultural productivity in Aceh. Recently fields were flooded for the massive Jatigede Dam in West Java, after 20 years of delays. Once complete, the dam will irrigate 90,000 hectares of rice paddy, increasing efficiency by giving farmers two harvests a year instead of one.

(Sources: adapted from http://www.economist.com)

Extract C

Why Germany keeps to budget rules despite a slowdown in growth

Germany’s economic boom is over, as it has entered recession. During the last ten years of economic growth, well over 4 million jobs were created.

The fear of recession has revived a debate in Germany: should the government spend more to stimulate growth? It is written into the German constitution that the fiscal deficit cannot be greater than 0.35% of GDP once the effects of the economic cycle have been removed. Germany’s budget has been in surplus since 2014 and the government is always reluctant to increase spending, which would create a deficit. In 2018, aided by booming employment and low interest costs on existing debt, the budget ran to a surplus of 1.9% of GDP.

Germany’s main trading partners have long been angered by German fiscal policy. The French President criticised Germany’s budget and current account surpluses that “always occur at the expense of others.”

Large parts of Germany’s infrastructure need significant investment. As the economy has slowed, a decision to run a balanced-budget policy has become harder to defend. In wealthy regions of Germany, crumbling schools have been closed for fear of collapse, and information and mobile technology on a wide scale need to be modernised. The World Economic Forum reported that accessibility of fibre optic broadband also “remains the privilege of the few.” However, private sector firms, such as major motor manufacturers, are still willing to invest in new technology, and the profitability of some of these firms, in the long run, benefits as a result.

The state development bank puts Germany’s investment shortfall at €138 billion (£120 billion). Arguments for a much more expansionary fiscal policy have failed to influence government policy. Big government programmes, such as a recent package to reduce Germany’s carbon emissions, are only implemented when they satisfy fiscal rules.

(Source adapted from: The Economist Nov 14th 2019 and https://www.ft.com)

Extract A

Tough market conditions for coffee shops – but coffee quality is king

UK coffee shop chains have experienced slow growth opportunities and rising costs. In 2019 the UK market leader, Costa Coffee, opened over 60% fewer stores than in 2018, while Starbucks opened just three new stores overall in 2019.

By 2020, many costs were rising: staff shortages meant rising wages for baristas (trained coffee makers), a 6.2% National Minimum Wage increase for over 25-year-olds, and rising rents.

In a challenging UK economy, consumers placed coffee quality ahead of convenient location when choosing a coffee shop. This demonstrates the need for coffee shops to match rising expectations in the UK’s increasingly crowded coffee shop market in order to stay competitive. Independent coffee shops (a total of 25,892 shops in 2020) remain a threat to the branded coffee shops as they pursue a unique luxury experience for customers. This will often focus on the atmosphere and customer service, luxury food and drink ranges, and being a part of the local community. Independent coffee shops run on average profit as low as 2% of revenue, and many go out of business as new chains arrive in a locality.

In January 2020, Coca-Cola finalised its £3.9 billion takeover of market leader Costa Coffee. The Coca-Cola company’s stated aims are to maximise long-term returns to shareholders while being mindful of overall responsibilities such as supporting sustainable communities. Major brands, such as Costa, continue to lead coffee shop expansion in 2020 as competition intensifies.

(Source: adapted from https://www.worldcoffeeportal.com)

The UK economy

Figure 1: UK gas prices in pence per therm, August 2002 to August 2022

Figure 2: UK inflation, CPI, August 2002 to August 2022