Shutdown (economics)

(total revenue equals or exceeds variable costs), in order to continue operating.

Thus, a firm will find it profitable in the short run to operate so long as the market price equals or exceeds average variable cost (p ≥ AVC).

[3] Conventionally stated, the shutdown rule is: "in the short run a firm should continue to operate if price equals or exceeds average variable costs.

"[4] Restated, the rule is that to produce in the short run a firm must earn sufficient revenue to cover its variable costs.

[7] Because fixed costs must be paid regardless of whether a firm operates they should not be considered in deciding whether to produce or shut down.

On the other hand if VC > R then the firm is not even covering its short-run production costs and it should immediately shut down.

The rules are equivalent—if one divides both sides of inequality TR > VC (total revenue exceeds variable costs) by the output quantity Q one obtains P > AVC (price exceeds average variable cost).

[19] Under these circumstances, even at the profit-maximizing level of output (where MR = MC, marginal revenue equals marginal cost) average revenue would be lower than average variable costs and the monopolist would be better off shutting down in the short run.

However, there can be physical assets whose cost during production is fixed but which have a salvage value which can be obtained if there is a shutdown.

In the long run, the firm will have to decide whether to continue in business or to leave the industry and pursue profits elsewhere.

A firm that has exited an industry has avoided all commitments and freed all capital for use in more profitable enterprises.

[26] A firm that exits an industry earns no revenue but it incurs no costs, fixed or variable.

[31] The short run shutdown point for a competitive firm is the output level at the minimum of the average variable cost curve.

The long run shutdown point for a competitive firm is the output level at the minimum of the average total cost curve.

To find the shutdown point in the long run, first take the derivative of ATC and then set it to zero and solve for Q.

Average Variable Cost (AVC), Average Total (Fixed plus Variable) Cost (AC), Average Fixed Cost (AFC), marginal cost (MC). The short-run optimal quantity of output occurs where marginal cost intersects marginal revenue (not shown; horizontal for a perfect competitor , otherwise downward sloped). If at this output level the height of the average revenue curve (not shown; horizontal for a perfect competitor, otherwise downward sloped) is less than the height of the average variable cost curve, the firm will shut down production of the good in the short run to avoid negative profit.
The optimal quantity of output for the perfect competitor is where marginal cost (MC) equals marginal revenue (MR). In the case depicted, since at this quantity of output average revenue (AR) exceeds average variable cost (not shown, but below average total cost (ATC)), the firm in this situation does not shut down.