3.6 Firms' Short-Run Decisions to Produce and Long-Run Decisions to Enter or Exit a Market

In the short run, fixed costs are sunk, the firm pays them whether or not it produces. So the shutdown rule compares price to average variable cost only: if P ≥ AVC, producing covers all variable costs and contributes something toward fixed costs, so operate (even at a loss); if P < AVC, every unit deepens the loss, so shut down and lose only fixed costs.

The shutdown point is the minimum of the AVC curve, and the break-even point is the minimum of ATC. Between them (AVC ≤ P < ATC) the firm operates at a loss in the short run. This is also why a competitive firm's short-run supply curve is its MC curve above minimum AVC.

In the long run nothing is fixed, so the standard is stricter: firms exit an industry if P < ATC (economic losses) and new firms enter if P > ATC (economic profits). Entry and exit shift market supply until price settles at minimum ATC and economic profit is zero.