shut down

o A company is considered to have shut down, if it temporary ceases production but keeps fixed capital. A company has exit the industry when it has made a permanent decision to leave the industry. The decision to temporarily shut down a business depends on a few factors.

o A firm will want to shut down in the short run when it can no longer cover its variable costs.


o The critically low market price at which revenues just equal variable costs is (or, equivalently, at which losses exactly equal fixed costs is called the shutdown point.

o If prices go up than shutdown point, the firm will produce along its marginal cost curve because, it would lose more money by shutting down.



o if a business shuts down, its total revenue becomes zero, and its total cost equals the fixed cost. So the company should continue producing its product, as long as it covers its variable costs. The firm therefore produces where profit equals marginal cost.


The zero-profit point comes where price is equal to AC, while the shutdown point comes where price is equal to AVC. Therefore, the firm’s supply curve is the solid rust line in figure. It first goes up the vertical axis to the price corresponding to the shutdown point at M1, where P equals the level of AVC and then continuous up the MC curve for prices above the shutdown price.

The analysis of shutdown conditions leads to the surprising conclusion that profit-maximizing firms may in the short run continue to operate even through they are losing money. This condition will hold for firms that are heavily indebted and therefore have high fixed costs.

For these firms, as long as losses are less than fixed costs profits are maximized and losses are minimized when they are able to pay the fixed costs.