Shutdown Point
What is Shutdown Point?
The shutdown point is the output level where price equals minimum average variable cost.
If price falls below this point, the firm cannot cover its variable costs and should shut down in the short run to minimize losses. It continues operating if price is at or above minimum AVC, even if it incurs a loss.
Shutdown Point: a worked example
A print shop owes $1,200 a month in rent it cannot escape. At 300 shirts a month its variable costs run $2,400, so AVC = 2,400 / 300 = $8. At a price of $9, revenue is 300 x 9 = $2,700, which covers the $2,400 of variable cost and leaves $300 toward rent, so the loss is 2,700 - 3,600 = $900 rather than the full $1,200. Now let price fall to $7. Revenue is 300 x 7 = $2,100, short of variable cost, and the loss grows to 2,100 - 3,600 = $1,500. Shutting down and losing only the $1,200 of rent is the better call.
The mistake students make with shutdown point
The tempting rule is that losing money means closing, so students shut the firm as soon as price dips under average total cost. That is the break-even point, not the shutdown point. Between minimum AVC and minimum ATC the firm loses money and should still produce, because the rent is owed whether the machines run or not, and any revenue above variable cost chips away at it. Closing there means losing every dollar of fixed cost instead of only part of it.
Shutdown Point questions
Should a firm shut down if it is losing money?
A firm that is losing money should keep producing in the short run as long as price is at or above minimum average variable cost. Every dollar of revenue beyond variable cost shrinks the loss on fixed costs the firm owes anyway. Only when price falls under minimum AVC does producing add to the loss, and at that stage the smaller loss comes from shutting down.
What is the difference between the shutdown point and the break-even point?
The shutdown point sits at the bottom of the average variable cost curve, while the break-even point sits at the bottom of the average total cost curve. Between the two, a firm covers its variable costs and part of its fixed costs, so it operates at a loss and keeps going. Below the shutdown point it cannot even cover variable costs, so it stops producing.
Why does the shutdown decision ignore fixed costs?
The shutdown decision ignores fixed costs because they are sunk in the short run. Rent on a signed lease is owed whether output is zero or 10,000 units, so that cost appears on both sides of the comparison and cannot change which choice is cheaper. Only variable costs, which disappear the moment production stops, belong in the decision.
Formula / Example
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