A firm’s Revenue is equal to the price they charge x the quantity sold. A firm’s total costs is equal to its variable costs plus fixed cost. Variable costs are costs that do change with output, such as wages of contract workers. Fixed costs are costs that do not change with output, such as rent. Profit is equal to Revenue minus total costs.
Rising costs, due to a rise in wages, have increased firms’ variable costs. This has reduced firms’ profitability as can be seen on the following diagram. A rise in variable costs have shifted upwards the marginal and average costs curves from AC and MC1 to AC and MC1. As such, coffee shops’ supernormal profits fell from the area PCDC to P1ABC1.
However, to evaluate, profits may not fall as the increased costs may be offset by an increase in revenue. Brands like Costa may not be impacted by rising costs as they have opened 60 new stores allowing them to sell more coffee. As a result, revenues could have possibly increased by more than the rise in costs, allowing them to generate more profit (Revenue – costs).
Additionally, rising costs may decrease the profitability of firms as they may have to lay off workers. Due to an increase in the minimum wage, firms cannot afford to recruit as many workers and the output they produce may decrease. Therefore, they will be able to supply less coffee and may also have to close branches. As they are now selling less coffee, their revenue would fall. The impact of this can be seen diagrammatically with the MR and AR curves shifting downwards from MR1 and AR1 to MR2 and AR2, resulting in a fall in profits from P1DEC1 to PCAB.
However, profitability may not fall for all coffee shops. This could especially be the case for small coffee shops who don’t have many workers or shops who were already paying their workers more than the minimum wage. Thus, they may not suffer from significantly higher costs and therefore their profits may not change by much.
