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This example suggests that the key factor is whether a firm can earn enough revenues to cover at least its variable costs by remaining open. Let’s return now to our raspberry farm. [link] illustrates this lesson by adding the average variable cost curve to the marginal cost and average cost curves. At a price of $2.20 per pack, as shown in [link] (a), the farm produces at a level of 50. It is making losses of $56 (as explained earlier), but price is above average variable cost and so the firm continues to operate. However, if the price declined to $1.80 per pack, as shown in [link] (b), and if the firm applied its rule of producing where P = MR = MC, it would produce a quantity of 40. This price is below average variable cost for this level of output. If the farmer cannot pay workers (the variable costs), then it has to shut down. At this price and output, total revenues would be $72 (quantity of 40 times price of $1.80) and total cost would be $144, for overall losses of $72. If the farm shuts down, it must pay only its fixed costs of $62, so shutting down is preferable to selling at a price of $1.80 per pack.

The shutdown point for the raspberry farm

The graphs show that despite negative profits (i.e. losses), firms can continue to operate. However, when prices drop beneath variable cost, firms will shut down
In (a), the farm produces at a level of 50. It is making losses of $56, but price is above average variable cost, so it continues to operate. In (b), total revenues are $72 and total cost is $144, for overall losses of $72. If the farm shuts down, it must pay only its fixed costs of $62. Shutting down is preferable to selling at a price of $1.80 per pack.

Looking at [link] , if the price falls below $2.05, the minimum average variable cost, the firm must shut down.

Cost of production for the raspberry farm
Quantity Total Cost Fixed Cost Variable Cost Marginal Cost Average Cost Average Variable Cost
0 $62 $62 - - - -
10 $90 $62 $28 $2.80 $9.00 $2.80
20 $110 $62 $48 $2.00 $5.50 $2.40
30 $126 $62 $64 $1.60 $4.20 $2.13
40 $144 $62 $82 $1.80 $3.60 $2.05
50 $166 $62 $104 $2.20 $3.32 $2.08
60 $192 $62 $130 $2.60 $3.20 $2.16
70 $224 $62 $162 $3.20 $3.20 $2.31
80 $264 $62 $202 $4.00 $3.30 $2.52
90 $324 $62 $262 $6.00 $3.60 $2.91
100 $404 $62 $342 $8.00 $4.04 $3.42

The intersection of the average variable cost curve and the marginal cost curve, which shows the price where the firm would lack enough revenue to cover its variable costs, is called the shutdown point . If the perfectly competitive firm can charge a price above the shutdown point, then the firm is at least covering its average variable costs. It is also making enough revenue to cover at least a portion of fixed costs, so it should limp ahead even if it is making losses in the short run, since at least those losses will be smaller than if the firm shuts down immediately and incurs a loss equal to total fixed costs. However, if the firm is receiving a price below the price at the shutdown point, then the firm is not even covering its variable costs. In this case, staying open is making the firm’s losses larger, and it should shut down immediately. To summarize, if:

  • price<minimum average variable cost, then firm shuts down
  • price = minimum average variable cost, then firm stays in business

Questions & Answers

what is Price mechanism
Dhany Reply
introduction to economics
Uday Reply
welfare definition of economics
Uday
examine the wealth and welfare definitions of economics
Uday
read book by ml jhingan
Anand
What do we mean by Asian tigers
Aeesha Reply
Dm me I will tell u
Shailendra
Hi
Aeesha
hi
Pixel
What is Average revenue
KEMZO
How are u doing
KEMZO
it is so fantastic
metasebia
uday
Uday
it is a group of 4 countries named Singapore, South Korea, Taiwan and Hong Kong because their economies are growing very faster
Anand
what's a demand
Edward Reply
it is the quantity of commodities that consumers are willing and able to purchase at particular prices and at a given time
Munanag
quantity of commodities dgat consumers are willing to pat at particular price
Omed
demand depends upon 2 things 1wish to buy 2 have purchasing power of that deserving commodity except any from both can't be said demand.
Bashir
Demand is a various quantity of a commodities that a consumer is willing and able to buy at a particular price within a given period of time. All other things been equal.
Vedzi
State the law of demand
Vedzi
The desire to get something is called demand.
Mahabuba
what is the use of something should pay for its opportunity foregone to indicate?
Random Reply
Why in monopoly does the firm maximize profits when its marginal revenue equals marginal cost
astrid Reply
different between economic n history
Falma Reply
If it is known that the base change of RM45 million, the statutory proposal ratio of 7 per cent, and the public cash holding ratio of 5 per cent, what is the proposed ratio of bank surplus to generate a total deposit of RM 300 million? 
Jeslyne Reply
In a single bank system, a bank can create a deposit when it receives a new deposit in cash. If a depositor puts a cash deposit of RM10,000 into the bank, assume the statutory reserve requirement is 7% and the bank adopts a surplus reserve of 8%. a. Calculate the amount of deposits made at the end o
Jeslyne
the part of marginal revenue product curve lies in the _ stage of production is called form demand curve for variable input.
Bashir Reply
The cost associated with the inputs owned by the farmer is termed as
Bashir
the cost associated with inputs owned by the farmer is termed as ____
Bashir
why do we study economic
Nwobodo Reply
we study economics to know how to manage our limited resources
Eben
တစ်ဦးကျဝင်​ငွေ
myo
we study economics the know how to use our resources and where to put it
Mamoud
what is end
Nwobodo
we study economics to make rational decision
Gloria
we study economics only to know how to effectively and efficiently allocate our limited resource in other to meet our unlimited wants
Kpegba
We study economics inorder for us to know the difference of the needs and wants and aslo how to use the limited resources that are available
Bongani
who is the father of economy
Yajanyi Reply
adam smith
ibrahim
Adam smith
Somnath
professor Lionel Robins
Abraham
adam smith
albert
mariginal utility is finalized by who?
Barsharani
marshall
Aadi
Adam Smith
Laila
Adam smith
Mamoud
Adam Smith
Bongani
Adam smith
Veronica
adam smith barter system
Omed
why we study economics
Kitojo Reply
what is equilibrium price?
BENJAMIN Reply
This is the price In which quantity demanded is equal to the quantity supplied.
Binta
what is the principle of demand
Udoh
is when the price of two item is equal
Mamoud
is the market price at which the demand curve and supply curve of particular commodity interest.
Kpegba
can we say that without macroeconomics,microeconomics can succeed? and why?
Kpegba
equilibrium price is when prices are equal
Ramon
equilibrium price is a point at which demand and supply curve meet
Vedzi
please can you give us the correct answer after the lesson to be compared to our answers
Gloria Reply
in what?
ibrahim
why economics is the real life subject
Kitojo
because it is subjected to human decisions
Kpegba
why might an increase in money national income not necssarily lead to an increase in the standards of living
Multin
pls,who is a legal tender.can you explain well
Mary Reply
We think, that the legal tender is a form of payment of a debt or anything related, but which is not necessarily money. that can be bank notes, or coins for instance. but the bottom line is the legal tender is required to be recognized by the law, but it varies according to the jurisdiction.
Pierre
Thanks
Mary
Is it something like cheque
Mary
legal tender is anything that can be accepted for payment within a country
Tyson
good
Philo
is Something legally accepted in a particular place
Mamoud

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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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