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Shutting Down to Minimize Loss
TABLE 9.3 A Firm Will Shut Down If Total Revenue Is Less Than Total Variable Cost
CASE 1: SHUT DOWN CASE 2: OPERATE AT PRICE = 1.50
Total Revenue q = 0 Total revenue 1.50 x 800
1,200 Fixed costs
Variable costs Total costs
+ 2,000
2,000 Fixed costs
Variable costs Total costs
+ 2,000
1,600 3,600
Profitloss TR TC: 2,000
Operating profitloss TR TVC 400
Total profitloss TR TC 2,400
Any time that price average revenue is below the minimum point on the average variable cost curve, total revenue will be less than total variable cost, and operating profit will be
negative
—that is, there will be a loss on operation. In other words, when price is below all points on the average variable cost curve, the firm will suffer operating losses at any possible
output level the firm could choose. When this is the case, the firm will stop producing and bear losses equal to fixed costs. This is why the bottom of the average variable cost curve is
called the shut-down point. At all prices above it, the marginal cost curve shows the profit- maximizing level of output. At all prices below it, optimal short-run output is zero.
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The short-run supply curve of a competitive firm is that portion of its marginal cost curve that lies above its average variable cost curve Figure 9.3.
shut-down point The lowest point on the
average variable cost curve. When price falls below the minimum point on AVC,
total revenue is insufficient to cover variable costs and the firm will shut down
and bear losses equal to fixed costs.
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FIGURE 9.3 Short-Run Supply Curve of a Perfectly Competitive Firm
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