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The shutdown point

The possibility that a firm may earn losses raises a question: Why can the firm not avoid losses by shutting down and not producing at all? The answer is that shutting down can reduce variable costs to zero, but in the short run, the firm has already paid for fixed costs. As a result, if the firm produces a quantity of zero, it would still make losses because it would still need to pay for its fixed costs. So, when a firm is experiencing losses, it must face a question: should it continue producing or should it shut down?

As an example, consider the situation of the Yoga Center, which has signed a contract to rent space that costs $10,000 per month. If the firm decides to operate, its marginal costs for hiring yoga teachers is $15,000 for the month. If the firm shuts down, it must still pay the rent, but it would not need to hire labor. [link] shows three possible scenarios. In the first scenario, the Yoga Center does not have any clients, and therefore does not make any revenues, in which case it faces losses of $10,000 equal to the fixed costs. In the second scenario, the Yoga Center has clients that earn the center revenues of $10,000 for the month, but ultimately experiences losses of $15,000 due to having to hire yoga instructors to cover the classes. In the third scenario, the Yoga Center earns revenues of $20,000 for the month, but experiences losses of $5,000.

In all three cases, the Yoga Center loses money. In all three cases, when the rental contract expires in the long run, assuming revenues do not improve, the firm should exit this business. In the short run, though, the decision varies depending on the level of losses and whether the firm can cover its variable costs. In scenario 1, the center does not have any revenues, so hiring yoga teachers would increase variable costs and losses, so it should shut down and only incur its fixed costs. In scenario 2, the center’s losses are greater because it does not make enough revenue to offset the increased variable costs plus fixed costs, so it should shut down immediately. If price is below the minimum average variable cost, the firm must shut down. In contrast, in scenario 3 the revenue that the center can earn is high enough that the losses diminish when it remains open, so the center should remain open in the short run.

Should the yoga center shut down now or later?
Scenario 1
If the center shuts down now, revenues are zero but it will not incur any variable costs and would only need to pay fixed costs of $10,000.
profit = total revenue–(fixed costs + variable cost)           = 0 –$10,000           = –$10,000
Scenario 2
The center earns revenues of $10,000, and variable costs are $15,000. The center should shut down now.
profit = total revenue   (fixed costs + variable cost)           = $10,000   ($10,000 + $15,000)           = –$15,000
Scenario 3
The center earns revenues of $20,000, and variable costs are $15,000. The center should continue in business.
profit = total revenue   (fixed costs + variable cost)           = $20,000   ($10,000 + $15,000)           = –$5,000

Questions & Answers

the is the situation in which the need of individuals exceed the available resource. increase in population rate and wrong decision making
esther Reply
what is the different between wants and demand?
wants are what people desire to have but they can live without them and demand is a thing that is most wanted
what are the demand pull inflation
the higher the aggregate level of activity, the larger the proportion of areas and industries which experience excess demand for goods and labour of various sorts , and the more powerful is demand-inflationary pressure . Demand inflation is contrasted with cost inflation , in which price and wage
increases are transmitted from one sector to another. These should be regarded as different aspects of an overal inflation starts , cost inflation explains why inflation once begun is so difficult to stop.
what is the important difference between positive and normative economics
positive economics is the study of how an economy works in practice, as opposed to the theoretical study of how it should run in theory and normative economics is the party of economics that is concerned with how the economy ought to be run.
positive economic deal with fact and also talks about how the economy actually is like while normative economic deal with value judgement and talks about how the economy ought to be like
What is the difference between opportunity cost and choice
opportunity cost are also known as forgun alternative why choice is to select one among alternative
importance of economic
Zakaria Reply
satisfaction of human wants
economics is about to economise . discuss
Angel Reply
Underlines the efficiency aspect. Economise towards what: Economise factors to reach equal distribution of Material wealth or Just to operate optimally to Service demand, i. e. Run markets efficiently?
join the conversation
abba Reply
what is terms of trade
Ibrahim Reply
different btn import and export
No question... This is nice
Gbenga Reply
hw can we solve problem of scarcity
scarcity is not necessarily a problem but a constant condition of the world. there are not enough resources to satisfy the unlimited wants.
wee need to be cooperative
by unlimited resourses and abundant want
why do compute GDP?
steven Reply
can anyone shortly determine the word inflation.
Ibrahim Reply
Continous increase in the general level of prices or in the cost of living.
persistent increased in general price level
all correct...
the father of economics
Reuben Reply
Adem smith
Adem smith
Adem smith sure
the father of economic regarding to adam Smith
the father of political of economic and capitalism in his book and inquary in to the wealth of the nation.
Adam Smith his the father of economic
difference between injection and leakage
what is monopoly
Monopoly is a market structure where there is one firm who dominate the industry
hi,, I am new here. please welcome me.
you are welcome
monopoly is the one characterized by a mkt power in which a firm is a price maker
Some member just ask questions but not answering so y this happen
Monopoly is a market where only one seller exists. No competition
how long does the patent right prevail the monopoly
no attempt
what is state farming
anybody to attempt
different types of price elasticity of demand with the aid of graphs
Tshepo Reply
what about mean median and mode
Dike Reply
mode is the most occurred number and median is the middle digit
the mean is the sum of all the data divided by the number eg: 2+4+4+5+3+5+1 =24÷7
what is exchange rate
thanks guys
What is Equilibrium?
that when supply equals demand. that's where the supply curve and the demand curve intercept.
equilibrium is when the both side of the price is balanced
Thanks Asuquo Agwuu
what is paradox Of drift
doris Reply
it's thrift not drift
so what is it sir
what are the causes of unemployment
Afful Reply
lack of job in the rural areas
High level of illiteracy
Unfulfilled government promises
this one no be problem waii
low rate of industrialisation
elements of economic
Muhammad Reply
Supply demand consumer and money.
please would you explain further about short run and long run
Doris Reply

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Source:  OpenStax, Principles of economics. OpenStax CNX. Sep 19, 2014 Download for free at http://legacy.cnx.org/content/col11613/1.11
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