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Reasons for Firms Becoming More Capital-Intensive

Consumers in Uruguay are eating more processed foods. Factors of production, including enterprise, have responded to this change. Firms in the processed food industry have become more capital-intensive. All of Uruguay’s industries were affected by the rise in its inflation rate, from 6.2% in 2017 to 7.7% in 2018

Analyse why a firm may become more capital-intensive (6 Marks)

Category:

Firm Behavior and Strategies

CIE JUNE 2021 O LEVEL

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Answer

Tip: This answer is longer than what is required for a 6 mark question. As a guide, to score a maximum number of marks for this type of question, you must provide 3 or more well-explained points.

(Step 1: Define 'capital-intensive' in the introduction)

In a capital-intensive firm, major costs occur from investments in equipment, machinery, or other expensive capital assets. There has been a trend for firms to make their processes more capital intensive to the point where some major activities, such as food processing, can largely be done by robots and computer-controlled machinery.

(Step 2: Give reasons why firms may become more capital intensive)

There are several reasons why a firm may be encouraged to become more capital intensive:

🤖 A firm may become more capital intensive to lower its cost of production

The cost of capital may be cheaper compared to the cost of labour. Furthermore, a capital intensive production process will increase efficiency and reduce wastage. The firm will benefit from an overall fall in the cost of production. This will enable it to sell at a more competitive price and increase its profit margin.

🤖 A firm with capital intensive production processes may benefit from better efficiency and an increased production capacity

A capital intensive production is more efficient. There will not be any costly production backlogs due to sicknesses, strikes or breaks. Not only can capital equipment produce more output in an hour, but it can also work for longer hours, up to 24 hours a day. Furthermore, wastage can be reduced, and the firm will be able to produce more output. Consequently, the firm will benefit from economies of scale and will be able to reduce the average fixed cost of capital.

🤖 A firm may be able to produce better quality products using capital equipment

Advances in technology may improve the performance of capital and produce better quality products. In labour-intensive production, there may be human error. A capital intensive production is particularly beneficial to a firm that wishes to produce uniform products of consistent quality. Providing superior quality products will help to retain existing customers and attract new ones.

For example, in the food processing industry, defects and problems can be noticed much earlier in the supply chain with the appropriate machine. By detecting issues during food processing and packaging, the total number of defective goods that enter the market can be cut down. There is better quality control.

🤖 The government may provide incentives such as tax reductions or subsidies upon the purchase of capital equipment

Subsidies and tax reductions will make the purchase of capital equipment more affordable.

🤖 A firm may become more capital intensive because of a shortage of labour

There may be a shortage of labour making it difficult to recruit new workers. By contrast, capital equipment is readily available.

(Step 3: Conclude)

Studies have shown that the main reason why firms become more capital intensive are: to reduce costs, to standardize output, to reduce waste, to improve work safety; and to improve quality and brand protection.


( Marking scheme)

Coherent analysis which might include:

The cost Of capital may fall / the price Of labour may
rise (1 ) lowering costs of production (1) making the firm
more price-competitive (1) may increase profits
Advances in technology (1 ) may improve the quality of
capital (1) making it more productive I efficient (1) may
increase the quality of products produced (1) raise
demand for the products produced (1).
Firms may want to reduce human error / more
consistent quality / uniform products (1) reduce
wastage
Firms may want to avoid disruption to production (1)
caused by industrial action / strikes I sickness (1)
capital equipment does not need to take breaks / can
work 24 hours a day (1).
There may be a shortage Of labour (l) making it difficult
to recruit workers (1).
A government may reduce taxes on capital goods (l)
provide subsidies (1) the rate of interest may be
reduced (1) making capital goods more affordable (1).
The firm's output may rise (1) reducing the average
fixed cost of capital I benefiting from economies of
scale

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