Question

Universal Shampoo is a price taker firm. Its costs are:   

Output (Shampoo per hour)	Total Cost ($ per hour)
0	10
1	21
2	30
3	41
4	54
5	69

a. Calculate Universal’s profit-maximizing output and economic profit if the market price is

(i)                  $14 a shampoo.

(ii)                $12 a shampoo

(iii)              $10 a shampoo

b. What is Universal’s shutdown point and its economic profit if it shuts down temporarily?

c. At what price will firms with costs identical to Universal’s exit the Shampoo market in the long run?

d. At what price will firms with costs identical to Universal’s enter the Shampoo market in the long run?

Answer 1

The firm is the price taker.

On the basis of the information provided, the marginal cost, fixed cost, variable cost, average cost, and average variable cost are as follows:

Output (Shampoo per hour)	Total Cost ($ per hour)	Marginal Cost MC	Total Fixed Cost TFC	Total Variable Cost TVC	Average Cost AC	Average Variable Cost AVC
0	10	-	10	0	-	-
1	21	11	10	11	21	11
2	30	9	10	20	15	10
3	41	11	10	31	13.66666667	10.33333333
4	54	13	10	44	13.5	11
5	69	15	10	59	13.8	11.8

a.

(i) If the market price = P = $14 per shampoo, the equilibrium is given by P = MC.

If there does not exist any output, that output would be the equilibrium quantity at which P > MC but beyond that output P < MC

This occurs at Q = 4

Hence, the firm's profit-maximizing output = 4

Economic profit = TR - TC = P*Q - TC

=14*4 - 54

= $2

If the market price = P = $12 per shampoo, the firm's profit-maximizing output = 3

Economic profit = TR - TC = P*Q - TC

=12*3 - 41

= $-5

If the market price = P = $10 per shampoo, the firm's profit-maximizing output = 2

Economic profit = TR - TC = P*Q - TC

=10*2 - 30

= $-10

b.

The Universal's shut down point is the minimum of average variable cost = $10

The economic profit if the firm shuts down temporarily = TR - TC

=0 - 10

= $ - 10

c.

The firms with costs identical to Universal’s would exit the Shampoo market in the long run if the price is below the minimum of average cost, that is the price lower than $ 13.5

d.

The firms with costs identical to Universal’s would enter the Shampoo market in the long run, when the price is above the minimum of average cost , that is the price higher than $13.5