Shut Down Price (Chain of Analysis)
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Last updated 5 Oct 2020
The shut down price are the conditions and price where a firm will decide to stop producing. It occurs where AR is less than AVC.
In the short run, a business will continue to supply products as long as their revenues at least cover variable costs. Revenue = AR x Q.
Variable costs are costs that vary directly with output such as raw materials, component parts and employees paid an hourly wage.
Providing that price per unit (AR) > average variable cost (AVC), then a contributionis being made to cover some fixed (overhead) cost
As a result the firm would be better off continuing production if we assume that fixed costs are lost if a shut-down decision is made.
But, if there is a fall in demand and price drops below AVC, then a firm might decide to shut-down production to minimise their losses.
This is because not enough revenue is being generated and total losses suffered would be higher if production continued.