Answer to Question #251507 in Economics for K K

Question

Mike’s shear Shop provides 4,000 hair cuts each month at average price of $5.00 per haircut. The common costs of operating the store are $12,000 per month. The business is considering hiring a photographer who would take pictures of customers after they had their hair cut. The price of the photographs would be $2.50 and it estimated that 2,000 customers would purchase the service each month. The total extra cost of the photographic service is 1,000 + 1Q per month, where Q is the number of photographs sold.

i) If the decision is to be based on incremental revenue and incremental cost, should the service be offered? Explain.

ii) If the decision is to be made on the basis of fully distributed costs and if the $12,000 in monthly common costs is to be apportioned based on the revenues from haircuts and photo sold each month, should the new service be offered? Why or not?

Answer 1

i) If the decision is to be based on incremental revenue and incremental cost, then at Q = 4,000 units the additional profit is:

TP = 2,5×4,000 - (1,000 + 1×4,000) = 5,000.

So, the service should be offered as it gains additional profit.

ii) If the decision is to be made on the basis of fully distributed costs and if the $12,000 in monthly common costs is to be apportioned based on the revenues from haircuts and photo sold each month, then:

TP = (5 + 2.5)×4,000 - (12,000 + 1×4,000) = 14,000.

So, the new service should be offered.