Answer to Question #249134 in Economics of Enterprise for Marz

Question

Unisex International Haircutters, Inc., faces the following demand function for haircuts per day: QD = 240 - 20P (a) Draw a figure showing the demand curve and the corresponding marginal revenue curve of the firm. On the same figure draw typical MC, ATC, and AVC curves showing that the best level of output is 80 haircuts per day, and that ATC = $10 and AVC = $6 at Q = 80. (b) How much profit or loss per haircut does the firm have? Does the firm remain in business in the short run? Why?

Answer 1

a. To first start drawing the graph, we need to find the value for price (Y-axis)

$P=12-\frac{1}{20}Q\\P=12-0.05Q$

To find out the MR curve, we have to consider that its absolute slope is twice the slope of the demand curve and is below the demand curve.

$MR=a-2bQ\\MR=12-0.1Q$

To compute the value of price, we have to plug in the quantity to the price formula

$P=12-0.05\times80\\P=\$8$

b. We can see from the graph that the firm is making losses (depicted in the colored area)

$Profit=Q\times(P-ATC)\\Profit=80\times(8-10)\\Profit=160$

Thus the company is making loss in amount of $160. As the average variable cost is $6 and price is $8, meaning that P>AVC, it pays for a monopolist to remain in business in the short run even if it incurs losses, as long as the price is larger than average variable cost. The excess price over average variable cost can be used to cover part of the fixed costs.