Shutdown Points

Shutdown Points

A shutdown point is the level of output and price at which continuing operations yields no economic benefit and a firm is better off ceasing production (temporarily or permanently). At this point the firm’s revenue covers exactly its total variable costs; any further fall in price or rise in variable costs makes operating loss-making relative to shutting down.

Key ideas

• Shutdown occurs when revenue from production no longer covers variable costs; fixed costs are irrelevant to the shutdown decision.
• In competitive markets, the practical rule is: shut down if market price is below the minimum average variable cost (P < AVC).
• If production generates a positive contribution margin (revenue exceeds variable costs), the firm should continue operating even if it incurs an overall loss, because those revenues help pay fixed costs.
• A shutdown can apply to an entire business or only part of its operations.

How it works

The shutdown point marks the threshold where marginal revenue equals marginal variable cost such that marginal profit becomes zero or negative. If price or output changes so that revenue falls below variable costs, operating creates larger losses than shutting down—because when shut down the firm avoids variable costs but still incurs fixed costs. If, instead, price rises above variable costs, continuing production reduces losses by contributing toward fixed costs.

In competitive markets the condition is commonly expressed as:
* Continue operating if P ≥ minimum AVC.
* Shut down if P < minimum AVC.

Fixed vs. variable costs

• Fixed costs: expenses that must be paid regardless of production (rent, long-term leases, certain minimum staffing, mortgage). Fixed costs are not part of the shutdown decision because they are incurred whether the firm operates or not.
• Variable costs: costs that vary with production (materials, production wages, utilities tied to output). Eliminating variable costs by shutting down can reduce losses when revenue cannot cover them.

Types and examples

• Temporary shutdowns: Firms may pause production during economic downturns until demand recovers (e.g., manufacturers scaling back during a recession).
• Seasonal shutdowns: Businesses with seasonal demand may shut down certain operations off-season (e.g., producers who only make a seasonal product while keeping core production year-round).
• Permanent exit: Technological change or lasting shifts in consumer preferences can make previously profitable production unviable (e.g., CRT television production ended as demand disappeared).

Practical takeaway

The shutdown decision focuses on short-run variable costs and whether current revenue covers them. If revenue covers variable costs, continue operating to offset fixed costs. If not, shutting down (fully or partially) minimizes losses until conditions change.