South-Western College Publishing - Economics  

Coffee is Now Served - In Inner City Shops
Subject Monopolistic Competition, Short- and Long-Run Equilibrium
Topic Product Markets
Key Words Retail companies, Spending power
News Story Many retail companies have avoided inner cities in spite of the spending power of residents. Starbucks, the gourmet coffee shop chain, was no exception. However, it has teamed up with Earvin "Magic" Johnson to open several shops in inner cities and other under-served black neighborhoods. Magic has already had success in opening inner city movie theaters. TGI Friday is also teaming up with Johnson in Atlanta.

The signs are good. It is reported that a new Starbucks near the Los Angeles airport is doing as well as one in west LA, and ranks highly in Southern California. The company is destroying the stereotypes about gourmet coffee drinkers. If it continues to be successful, other businesses are going to change their views and move into the inner cities.
(Updated August 12, 1998)

Questions
  1. Why is the coffee shop industry monopolistically competitive? Refer to all the assumptions underlying monopolistic competition.

  2. a.   How does Starbucks differentiate its coffee?
    b.   What effect does this have on its demand curve?

  3. a.   Draw a diagram of the market for Starbucks coffee. Include the demand and marginal revenue curves, together with the average total and marginal cost curves. Show the equilibrium price and output, and the amount of profit.
    b.   In what two ways does establishing Starbucks coffee shops in the inner city affect the demand curve for Starbucks coffee?
    c.   Illustrate the effect on Starbucks’ eqiuilibrium price, output, and profit?

  4. If Starbucks continues to be successful in inner cities, and other coffee shops follow suit, what will happen to Starbucks’ price, output, and profit? Draw a diagram illustrating Starbucks’ long-run equilibrium position. What will happen to equilibrium price, output and profit?
Source S. Liesman, B. Bahree, and J. Friedland, "‘Big 3’ Exporters’ Pact To Cut Oil Output Signals Seismic Shifts," The Wall Street Journal, June 23, 1998.

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