Hank 瀚克

LOS 14.e: Determine and interpret breakeven and shutdown points of production.

We define the short run for a firm as the time period over which some factors of production are fixed.

Typically, we assume that “capital ” is fixed in the short run so that a firm cannot change its scale of operations (plant and equipment) in the short run.

All factors of production (costs) are variable in the long run.

Shutdown and Breakeven Under Perfect Competition

A simple example:

Consider a retail store with a 1-year lease (fixed cost) and one employee (quasi-fixed cost)

So that variable costs are simply the store's cost of merchandise.

        If the total sales (total revenue) just covers both fixed and variable costs, price equals both average revenue and average total cost.

👉 We are at the breakeven output quantity, and economic profit equals zero.

During the period of the lease (the“short run”)

Items are being sold for “more” than their variable cost, the store should continue to operate to minimize losses. (P>VC 👉 continue)

Items are being sold less than their average variable cost, losses would be reduced by shutting down the business in the short run. (P<AVC 👉 shut down)

In the “long run”

A firm should shut down if the price is “less” than average total cost, “regardless of the relation between price and average variable cost.” (P<AC 👉 shutdown)

A firm under perfect competition 👉 Price = Marginal revenue = Average revenue

        For a firm under perfect competition (a price taker), we can use a graph of cost functions to examine the profitability of the firm at different output prices.

        (1.) At price P1, P1 =Marginal Revenue = Average Revenue = Average Total Cost. At the output level of point A, the firm is making an economic profit of zero.

        (2.) At a price above P1, economic profit is positive.

        (3.) At a price less than P1, economic profit is negative. (the firm has economic losses)

        (4.) At price between P1 and P2, the firm has losses, but the loss is less than the losses that would occur if all production were stopped. As long as total revenue is greater than average variable cost, at least some of the firm’s fixed costs are covered by continuing to produce and sell it’s product. If the firm were to shut down, losses would be equal to the fixed costs that still must be paid. As long as price is greater than average variable costs, the firm will minimize its losses in the short run by continuing in business.

        (5.) If average revenue(= price) is less than average variable cost, the firm’s losses are greater than it’s fixed costs, and it will minimize its losses by shutting down production in the short run.

        (6.) In the long run, all costs are variable, so a firm can avoid its fixed costs by shutting down. If price is expected to remain below minimum average total cost, the firm will shut down rather than continue to generate losses.

Shutdown and Breakeven under imperfect competition

For price-searcher firms (those that face downward-sloping demand curves), we could compare average revenue to ATC and AVC in order to identify shutdown and breakeven points.

However, marginal revenue is no longer equal to price. ( hence, analysis based total cost is better suited for examining breakeven and shut down points.)

(1.) TR = TC : Breakeven

        (2.) TC > TR > TVC : firm should continue to operate in the short run but shut down in the long run.

        (3.) TR < TVC : firm should shut down in the short run and the long run.

        Total cost equals total revenue at the breakeven quantities QBE1 and QBE2.

The quantity for economic profit is maximized is shown as QMAX.

If the entire TC curve exceeds TR (no breakeven point), the firm will want to minimize the economic loss in the short run by operating at the quantity corresponding to the smallest (negative) value of TR – TC.

圖片來源 CFA 2019 NOTE