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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

what does it array
Cbdishakur Reply
what are the differences between monopoly and.oligopoly
Onome Reply
what are the difference between monopoly and oligopoly
Cbdishakur
The deference between Monopoly and Oligopoly: Monopoly means:A single-firm-Industry producing and selling a product having no close business and Oligopoly means:A market structure where a few sellers compete with each other and each controls a significant portion of market .
Basanta
so that the price-output policy one affects the other.
Basanta
what is economic
Emakpor Reply
what is economic
Cbdishakur
the word economic was derived from the Greek word oikos (a house)and mein(to manage) which in effect meant managing a household with the limited funds available 🙂.
Basanta
good excample about scarsity
hon
An Enquiry into the nature and causes of wealth Nations, this book clearly defined what economic is🙂🙂🙏🙏 thank you...
Basanta
good example about scarcity: money,time, energy, human or natural resources. Scarcity of resources implies that there supply is very much limited in relation to demand.
Basanta
equilibrium is a situation in which economic forces such as demand and supply are balanced and in the absence of external influences,the value of economic variables will not change
Onome Reply
hmnn
Emakpor
marginal cost and marginal revenue is equilibrium .
Kho
yessss
Basanta
what is equilibrium
Rodrice Reply
policy prescriptions for unemployment
Jeslyne Reply
Am working on it
Blacks
Study
Janelle
study
simeon
what are the factors effecting demand sedule
Kalimu Reply
we should talk about more important topics, you can search it on Google n u will find your answer we should try to focus on how we can improve our society using economics
shubham
so good night
hon
ways of improving human capital
kelly Reply
what is human capital
kelly
Capital can be defined as man made assets use in production .
Abdulai
What is the differences between central Bank And Commercial Bank ?. 2 for each
Abdulai
Two types of bank clearing house.
Abdulai
what are the most durable assets of a bank
Ngongang
What is Opportunity Cost?
Cephas Reply
may be defined as expression of cost in terms of forgone alternative.
Abdulai
Helloo, im new, can i get to know more?
Saniya Reply
You ask questions on any topics you find difficult.
Favour
What is opportunity cost?
Cephas
is price elasticity of demand the same as elasticity of demand
Favour Reply
not really
Victoria
hi
Gh
hello
Bhartendu
i hope everyone be ok
Gh
No
Hassan
please explain
Favour
No
William
explanations please
cleophas
price elasticity of demand is the reaction of customers /demand to price changes(increase or decrease) elasticity of demand is the reaction of prices brought about by the change in demand
Victoria
thank you
Favour
state the laws of demand and supply
William
dd: when price rises demand decreases whereas when price reduces dd rises ss: when ss rises the price rises and when ss decreases price also reduces. There is a positive relationship
Dhoonah
nice
Victoria
Draw a demand curve graph
William
though price elasticity and elasticity are used interchangeably, the demand can respond to income changes and prices of related goods as well.
Gurpalak
explain the difference between merit goods and public goods and show why it is possible for profit to be made in the supply of one of these types of good but not the other
Kavishek
Public goods are defined as products where, for any given output, consumption by additional consumers does not reduce the quantity consumed by existing consumers. Merit goods are, for example, education and to some extent the health-care. They are provided by state as "good for you".
ahmed
The ladies are doing much better than the men
Blacks
what happens when there is a shift in demand curve?
Favour
What is Specialization ? Explain in detail
Muhammad
any one ?
Muhammad
specialisation is a method of production whereby an entity focuses on the production of a limited scope of goods to gain a greater degree of efficiency.
Favour
It's ok
Muhammad
hello
Onome
yah
Abdulai
No. price elasticity of demand refers to the manna in which price of good demanded fluctuate mean while elasticity of demand explains the way consumer change in their willingness as they plan or purchase a good
Ngongang
diffirence between demand and supply
Bonny
what is economic
Seray Reply
It is a social science which studies human behavior as a relationship between ends and scarce which have alternative uses
Obeng
what is norminal wage
Demba Reply
is the wages measured in money as distinct from actual purchasing power
Favour
what is demand curve
Azeez Reply
this is a curve that slop downward from left to rich
Obeng
yes
Basanta
different between capital and wealth
Samuel Reply
Wealth refers to the amount of asset you have, while, capital is the amount of cash money you have with you now and willing to invest in any business.
Favour

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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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