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The Shutdown Point

The document discusses the conditions under which a firm should continue or shut down production in the short run and long run. In the short run, a firm should continue production if total revenue exceeds total variable costs and total costs exceed total revenue. If not, it should shut down to avoid fixed costs. In the long run, a firm should continue if price is above average total costs, as there are no fixed costs. The document also provides strategies like automation and lean manufacturing to potentially increase productivity and revenue.

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Bhagirath Baria
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97 views1 page

The Shutdown Point

The document discusses the conditions under which a firm should continue or shut down production in the short run and long run. In the short run, a firm should continue production if total revenue exceeds total variable costs and total costs exceed total revenue. If not, it should shut down to avoid fixed costs. In the long run, a firm should continue if price is above average total costs, as there are no fixed costs. The document also provides strategies like automation and lean manufacturing to potentially increase productivity and revenue.

Uploaded by

Bhagirath Baria
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd
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The shutdown point

When a firm is making a loss, it will have to decide whether to continue production or not. This
decision will, in fact, depend on the different total costs levels and whether the firm is operating
in the short run or in the long run.
If the firm is in the short run, and is making a loss whereby:

Total costs (TC) is greater than total revenue (TR)

and whereby total revenue is equal to total variable cost (TVC)

it is advisable for the firm to continue production. If it fails to achieve these conditions, it is
advised to close down so that the only costs the firm will have to pay will be the fixed costs.
Even if the firm stops producing, it will have to continue to meet the level of fixed costs. Since
whether the firm produces or not, it will have to pay fixed costs, it is better for it to continue
production in an attempt to decrease total costs and increase total revenue, thus making profits.
This can be done by:

Increasing productivity. The most obvious methods involve automation and


computerization which minimize the tasks that must be performed by
employees. All else constant, it benefits a business to improve productivity,
which over time lowers cost and (hopefully) improves ability to compete and
make profit.

Adopting new methods of production like Just In Time or lean manufacturing


in an attempt to reduce costs and wastages.

In the long run, the condition to continue producing requires the price P to be higher than the
ATC, i.e. the line representing market price should be above the minimum point of the ATC
curve.
If P is equal to ATC, the firm is indifferent between shutting down and continuing to produce.
This case is different from the short run shut down case because in long run there's no longer a
fixed cost (everything is variable).

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