Loss Minimization and Shutdown in the Short run

In the short run the maximum the firm must loose is its fixed cost. Ifthe firm can recover all its variable cost it may as well operate unlessit sees no hope of improvement in the future. In Figure VII.5 the firmis earning above normal profits by producing at QH output. If the pricewere to fall to CB (which is consistent with the minimum of the ACfunction) the firm would earn normal profits. (Remember that normalprofits are included in the cost functions as an opportunity cost for theentrepreneur.) If the price falls below CB, the firm will lose money, i.e.will earn less than normal profits. So long as the price is above CC, thefirm is recovering all the variable cost and a little more to offset thefixed cost that it would have lost if the firm would have shutdown. At aprice of CC, the firm is recovering all its variable cost and losing itsfixed cost (which it would have done anyway if it had closed down.).

Therefore, so long as the firm can recover all its variable costs at aprice of CC, it may as well operate in the short run. Point C, at a priceof CC and output of QC is called the shutdown point. It will always beat the point where the MC intersects the AVC (the minimum of theAVC).

In the long run all costs are variable, therefore the shut down point inthe long run is the minimum of the LRAC where MC= LRAC.There may be other reasons for operating a production facility. In somecases individuals may operate at less than normal profits because theget non-monetary benefits from being in a particular line of work orbeing “their own boss.” A government may encourage firms thatproduce particular products to operate for reasons of national defenseor national pride. In these cases public policy may be used to subsidizethe firms that would find it necessary to shut down in a free marketeconomy.

P_x

С,Р МС С,Р MC

AТC AТC

AVC AVC

Р

Р

Q Q

С,Р МС С,Р MC

AТC AТC

Р

Р AVC AVC

Q Q

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