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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

With the aid of diagrams,compare the short run equilibrium positions of a perfect competitor and an imperfect competitors
Monlay Reply
What is the term consultation in economics?
Nthabiseng Reply
why is it that the long run Average cost curve does not touch that of the short run curve at its minimum?
Baah Reply
In few words, what is the role of interest rate in economy?
Carlos Reply
what is population
Nyakeh Reply
total number of people in a given area or country
Clement
the total number of people at a given area or country
Clement
total number of people in a given area or country
okhiria
What is price Elasticity of demand?.
Samuel
The responsiveness of the quantity of a commodity demanded to a change in its price, expressed as the percentage change in quantity demanded divided by the percentage change in price.
EMMANUEL
why is it that the long run Average cost doesn't touch the short run cost curve at its minimum?
Baah
what is supply
Precious
please rice and beans will be what type of demand but note we mostly cook it together
Oladosu Reply
complementary or joint demand
Yillah
but did you know you can demand for rice without beans so how is it joint or complementary
Oladosu
From my point of view, rice and beans are replaceable goods, hence they can't be complementary.
Carlos
what are the money value
Wisdom Reply
Nothing more than a purchase power, in other words, $100 now, must have the same value after 1 year.
Carlos
what is Monopoly
Rebecca Reply
what is money
Lawal Reply
It can be define as a big transaction that can control any business for one place to another base.
Akinlo
money is recognisable note to accept both parties selling and buying
Hassan
i don still understan
Rene
hey
Abdul
hi
Rene
money is anything generally accepted as a medium of exchange
Awwal
Money is anything generally accepted as a medium of exchange and for the settlement of goods and services .
Korda
hi good ppl, pls help out
Tumi
discuss human and natural resources as develop strategies ro improving living condition of citizens in developing countries.
Tumi
I don't understand the question.
Naomi
it's a form of currency used for 2 or more individuals or parties in order to reach their amicable personal or business attainment. one must understand that money itself can manifest in multiple fashions for which the individuals or parties adheres.
are u trying to say we shld discuss ways in which human natural resources help in improving living condition of citizens in developing countries?
Naomi
money is a legal thunder generally accepted as a medium of exchange for the payment of debt ,goods and services
Naomi
money is a way of payment.
Carlos
money is any thing that is generally accepted as a medium of exchange good for good and settlement of debt and means of payment
Yillah
money is nothing but a object which is used for exchange of goods and services.
Harshita
money is anything that is generally accepted as payment of goods and services and settlement of debt
Rebecca
what is demand
Melissa Reply
demand is where the customer is willing and able to buy goods and services during a given period of time
idk
demand is the ability and willingness of an individual to buy goods and services at a given price in a particular period of time
Alpha
demand is the ability to buy a specific quantities of goods and services at a given price and at a specific period of time
rosemary
what are the rules of demand
rosemary
Rosemary Nsebon, Do you mean laws of demand?
Alpha
what are the rules of demand
Rene
the rule of demand is the higher the price the lower the quantity demanded and the lower the price the higher the quantity demanded
mbi
thank
Rene
what is unemployment
Rebecca
unemployment is a scenario or a phenomenon in an economy whereby people are willing are able to work but cannot a job
mbi
Suppose you have a team of two workers: one is a baker and one is a chef. Explain why the kitchen can produce more meals in a given period of time if each worker specializes in what they do best than if each worker tries to do everything from appetizer to dessert. please I need a urgent answer
Oladosu Reply
Enables individuals and countries to consume a variety of goods and services
Iddrisu
what is the meaning of competency
Oladosu Reply
competency is an ability and courage to do something perfectly
Abdullahi
ability to perform some task
Segun
rival
Ray
thanks 🙏 it is also the same with the core competency
Oladosu
A sufficient supply
Ebenezer
Ebenezer you mean the (core competency) right?
Oladosu
what is mean,median and mode
Ikeh Reply
mean is the average number of a given data
Gallant
median is the middle number of a given data
Gallant
in a given data sorry
Mitchel
hi
Sajib
Pls am new here
Physcal
what are development bank in Nigeria
Adedigba Reply
.hi
Physcal
hi
Adedigba
hw
Physcal
and cool
Rosie
nice to meet everyone
Rosie
hi how are dears
Mumtaz
how can we development economic in our country
Mumtaz
hi
Charm
Payroll and​ 4p
Wasuroj
Agriculture
Wasuroj
Export
Wasuroj
Transport
Wasuroj
Change management​ and​ cerrancy
Wasuroj
Empoyee
Wasuroj
Lawyer army and​ Lawyer​
Wasuroj
differentiate between choice and scale of preference
ALFRED Reply
choice are the various wants of every individual whiles scale of preference is the list of unsatisfied wants arranged in order of important priority
Kini
demand side approach to solve unemployment
Tshepiso 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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