Economics · Ch 10 — The Theory of the Firm under Perfect Competition
The Shut Down Point
The Shut Down Point
The Short-Run Shut Down Point
In the previous discussion on deriving the firm's supply curve, we established a critical rule: in the short run, a firm will continue to produce as long as the market price is greater than or equal to the minimum of its Average Variable Cost (AVC). This is not an arbitrary threshold — it is the boundary between covering your variable costs and failing to do so.
Why does this matter? Because in the short run, the firm has already incurred fixed costs (like rent on a factory or loan payments on machinery). These costs are sunk — they exist whether the firm produces zero units or a thousand units. So the firm's decision to produce or shut down hinges entirely on whether the revenue from selling output can cover the costs that change with production: the variable costs.
As we move down the supply curve, the price falls. The last price-output combination at which the firm still produces a positive output is precisely the point where the Short-Run Marginal Cost (SMC) curve cuts the AVC curve at its minimum. At this exact point, price equals the minimum AVC. Below this price, the firm would lose more by producing than by shutting down entirely.
The short-run shut down point is the minimum point of the AVC curve, where the SMC curve intersects it. Below this price, the firm produces zero output.
What Happens Below the Shut Down Point
If the market price falls below the minimum AVC, the firm cannot even cover its variable costs. Every unit it produces adds to the loss beyond the fixed costs it already must bear. In such a situation, the rational choice is to shut down — produce nothing — and accept a loss equal to the total fixed cost. That loss is smaller than the loss from producing at a price below AVC.
So the firm's short-run supply curve is not the entire SMC curve. It is only the portion of the SMC curve that lies above the minimum AVC. The shut down point marks the lower boundary of that supply curve.
A common mistake is to think the shut down point is where price equals minimum Average Total Cost (ATC). That is the break-even point, not the shut down point. The shut down point is about covering variable costs, not total costs.
The Long-Run Shut Down Point
In the long run, the situation changes fundamentally. There are no fixed costs — all costs are variable. The firm can adjust every input, including the scale of its plant. It can also exit the industry entirely without any sunk costs.
Because there are no fixed costs to absorb, the firm's decision to produce or exit depends on whether it can cover all its costs. The long-run shut down point is therefore the minimum of the Long-Run Average Cost (LRAC) curve. If the price falls below this minimum, the firm cannot earn normal profits in the long run and will exit the industry.
In the long run, the shut down point and the break-even point coincide — both are at the minimum of the LRAC curve. This is because in the long run, all costs are avoidable, so the firm must cover total costs to stay in business.
Summary of the Two Shut Down Points
| Time Horizon | Shut Down Point | Condition for Production | …