Hamad Kataria Midterm Test

University of Southampton, Semester 1, 2020/2021

ECON1001/ECON1003
Motivation: Recent lock-downs had and continue to have a profound effect on
corporate property markets, commuting, housing, catering, home delivery,
etc. Some of these changes appear to be permanent and far-reaching. For
some context and examples, please read the sources uploaded to Blackboard.

Question: What will happen as a result of these trends? State your thesis and
use microeconomic analytical tools to argue your point.

ANSWER:

The restrictions that are in place will harm small local businesses, leaving
many unemployed. In this case, I will analyse the effect of the pandemic on
restaurants.

Restrictions placed on firms nationwide due to the pandemic have made such
firms face supply chain issues, such as the introduction of new measures to
ensure the health and safety of the workforce and consumers. This means that
the costs for a firm rise due to rises in fixed costs, this can be illustrated using
the cost function:

C = rK+wL
*Cost denoted as C, r is rent, K is units of capital, w is the wage of workers, L is the
number of workers.

“rK”, which is the fixed cost rises as firms intend to purchase equipment to
remain open under the condition that strict hygiene is maintained and other
measures are met, for a restaurant it could be that the firm buys furniture to
accommodate the 2m rule.

Word count: 785 Student ID: 32030452

Hamad Kataria Midterm Test

With the rise in the firm’s cost, we can then determine if the profits of the firm
increase or decrease using the formula for profit:

Profit = revenue - cost

Profit = pq - (rK+wL)

The demand would fall as consumers know that you are vulnerable to getting
the virus when out in public, this makes going out to eat less attractive and so
quantity demanded and supplied falls, therefore the revenue that the firm
earns falls. As deduced previously, the cost rises, therefore profits fall due to
revenue falling and costs rising. As firms are profit maximising they would
need to make some adjustments.

Figure 1

Figure 1 is a monopolistic competition firm diagram. It shows the firm’s initial

revenues and costs curves before lockdown. Firms that are profit maximising
operate where MR=MC. Firms that have their AR=MR curve above or equal to
the AC curve can operate in the Long run.

I assume the restaurant is a monopolistic competitive firm and so it has the

following characteristics: there are a large number of firms, products are
slightly differentiated, low barriers to entry and non-price competition.

Word count: 785 Student ID: 32030452

Hamad Kataria Midterm Test

Once lockdown measures are in effect, costs rise and revenue falls. Costs rise
due to an increase in fixed cost, for the diagram, it means that AC would
increase as total cost increases:

AC = TC/q
*Average cost denoted as AC, Tc is total cost and q is the quantity

MC won’t change, this is due to MC being equal to the increase in cost due to a
change in quantity. The AR equals MR curve would fall/decrease as fewer
products are sold.

There are 2 outcomes that occur from AC rising and AR falling, one of which is
that the firm would continue to operate but profits would be cut considerably,
illustrated in figure 2, or the changes in both variables are significant enough
for the firm to operate in the short run and shut down in the Longrun as their
AR is below AC but above AVC, which is illustrated via figure 3.

Figure 2

Figure 2 shows a firms AC increasing and AR falling yet the firm is still able to
operate in the long run, however, if you compare the area of figure 2 profit to
figure 1’s, you would notice there is a decrease in the area and so profits have
fallen.

Word count: 785 Student ID: 32030452

Hamad Kataria Midterm Test

Figure 3

Figure 3 shows a firms AC increasing and AR falling, to the point that they
make loses, yet they will continue to operate in the short run but shut down in
the long run to minimize losses.

In either case, due to the climate of the pandemic, their only option is to cut
their costs. To do this in the short run, they would fire workers, this would
reduce the variable costs and consequently total costs, this would lower AC to
the point where the firm could make profits. In the long run, they would be
able to adjust capital and so can sell machinery to reduce costs.

There is evidence of this being the case as the unemployment rate has risen
from 4% in March, which was when the first lockdown took place to 4.8% in
September. However, the problem with this statistic is that it doesn’t represent
how many have been fired from work and so we are unable to see the full

In conclusion, if lockdowns and regulations were to continue, many would lose

their jobs and the government would be burdened to support those who are
then unemployed via benefits and programmes, the government would have to
increase spending to support families. This is already the case with the UK
chancellor proposing to spend £3billion for a 3-year “restart program” to help
unemployed get back into work.

Word count: 785 Student ID: 32030452