{"id":734,"date":"2020-03-24T04:51:49","date_gmt":"2020-03-24T04:51:49","guid":{"rendered":"https:\/\/pressbooks.ccconline.org\/accanderssenmicro\/chapter\/the-shut-down-decision\/"},"modified":"2023-07-13T01:15:45","modified_gmt":"2023-07-13T01:15:45","slug":"the-shut-down-decision","status":"publish","type":"chapter","link":"https:\/\/pressbooks.ccconline.org\/accanderssenmicro\/chapter\/the-shut-down-decision\/","title":{"raw":"The Shut Down Decision","rendered":"The Shut Down Decision"},"content":{"raw":"One of the more confusing concepts involves the firm's decision to shut down or keep prodcuing when losing money. Perhaps the following will help:<\/strong>\r\n\r\nThe Firm\u2019s Shut-Down Decision<\/strong>\r\n\r\nThe big decision faced by a firm that is losing money is whether to continue to operate or to shut down.\r\n\r\nTotal Revenue, Variable Cost, and the Shut-Down Decision\r\n\r\nIf a firm is losing money in the short run, would it be better to produce nothing at all or to continue operating at a loss? It depends on which choice minimizes losses.\r\n\r\nA firm\u2019s operating cost is the cost incurred by operating (rather than shutting down).\r\n\r\nThis is equivalent to variable cost.\r\n\r\nThe decision making rule is:\r\n\r\nOperate if total revenue > variable cost.\r\n\r\nEven if you are losing money, at least you can pay some of the fixed costs that will be paid in full if you shut down.\r\n\r\nShut down if total revenue < variable cost.\r\n\r\nThe Shut-Down Price\r\n\r\nA firm should continue to produce as long as total revenue is greater than operating cost, or price > average variable cost.\r\n\r\nA firm should shut down if total revenue is less than operating cost, or price < average variable cost.\r\n\r\nThe firm\u2019s shut-down price<\/strong> is defined as the price at which the firm is indifferent between operating and shutting down, P = MC = AVC. The shut-down price is equal to the minimum average variable cost.\r\n\r\nFixed Costs and Sunk Costs\r\n\r\nThe cost of the facility is a sunk cost<\/strong>, a cost that the firm has already paid or committed to pay, so it cannot be recovered (often the same as fixed cost). Thus, if the firm produces nothing, it will have a loss equal to the amount of fixed costs. If the firm operates, it will receive some revenues; as long as revenues exceed operating costs, the firm is better off.\r\n\r\n\"Original document by Peter Turner licensed CC BY\"<\/strong>","rendered":"

One of the more confusing concepts involves the firm’s decision to shut down or keep prodcuing when losing money. Perhaps the following will help:<\/strong><\/p>\n

The Firm\u2019s Shut-Down Decision<\/strong><\/p>\n

The big decision faced by a firm that is losing money is whether to continue to operate or to shut down.<\/p>\n

Total Revenue, Variable Cost, and the Shut-Down Decision<\/p>\n

If a firm is losing money in the short run, would it be better to produce nothing at all or to continue operating at a loss? It depends on which choice minimizes losses.<\/p>\n

A firm\u2019s operating cost is the cost incurred by operating (rather than shutting down).<\/p>\n

This is equivalent to variable cost.<\/p>\n

The decision making rule is:<\/p>\n

Operate if total revenue > variable cost.<\/p>\n

Even if you are losing money, at least you can pay some of the fixed costs that will be paid in full if you shut down.<\/p>\n

Shut down if total revenue < variable cost.<\/p>\n

The Shut-Down Price<\/p>\n

A firm should continue to produce as long as total revenue is greater than operating cost, or price > average variable cost.<\/p>\n

A firm should shut down if total revenue is less than operating cost, or price < average variable cost.<\/p>\n

The firm\u2019s shut-down price<\/strong> is defined as the price at which the firm is indifferent between operating and shutting down, P = MC = AVC. The shut-down price is equal to the minimum average variable cost.<\/p>\n

Fixed Costs and Sunk Costs<\/p>\n

The cost of the facility is a sunk cost<\/strong>, a cost that the firm has already paid or committed to pay, so it cannot be recovered (often the same as fixed cost). Thus, if the firm produces nothing, it will have a loss equal to the amount of fixed costs. If the firm operates, it will receive some revenues; as long as revenues exceed operating costs, the firm is better off.<\/p>\n

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