Shutdown Rule

Shutdown Rule and Profit

In the short run the business should shutdown if:

Why do we Ignore Fixed Costs in the Short Run?

Because a lot of fixed costs are sunk costs, which means they have already been paid and should not affect the firm's decision to stay open or shut down.

Example: Let's say you buy a restaurant and the oven costs you $10,000. This is a sunk cost (you have already paid it and cannot get it back). As long as you can pay for the food, chefs and waiters (the variable costs) at least you can survive.

• As long as the price is greater than the AVC, the firm can afford to meet its day to day expenses and survive (even if they are not making a profit) so they will stay open. This range is also called positive output because it shows where the business is actually willing to produce some output.
• If price is less than the AVC then firm cannot meet its day to day expenses and they must shut down. This range is also called negative output because it shows where the business is not willing to produce any output.
• The shutdown point on a graph is the point where MC = AVC. In the diagram below this would be at an output of ________
• Remember that the Price = MC at profit maximization.
• The supply curve is the upward sloping part of the ________ above its intersection with ________ because that shows us all the points the business will stay open and supply the product.

Profit

• If Price (P) = Average Total Cost (ATC) the firm will make ________ economic profit (Break-Even point). In the diagram above, this occurs at an output of ________ and a price of ________
• If P > ATC the firm will earn ________ economic profits. This is anywhere on the ________ of the break-even point.
• If P < ATC the firm will earn ________ economic profits. This is anywhere on the ________ of the break-even point.