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Economics

Study Notes

Shut Down Price (Short Run)

Level:
A Level
Board:
AQA, Edexcel, OCR, IB

The shut down price is the minimum price a business needs to justify remaining in the market in the short run

A business needs to make at least normal profit in the long run to justify remaining in an industry but in the short run a firm will continue to produce as long as total revenue covers total variable costs or price per unit > or equal to average variable cost (AR = AVC). This is called the short-run shutdown price.

The reason for this is as follows.

  • A business’s fixed costs must be paid regardless of the level of output.
  • If we make an assumption that these costs cannot be recovered if the firm shuts down then the loss per unit would be greater if the firm were to shut down, provided variable costs are covered.
Diagram to illustrate the short-run shut down price

Average revenue (AR) and marginal revenue curves (MR) lies below average cost, so whatever output produced, the business faces making a loss i.e. P<AC

At price P1 and output Q1 (where marginal revenue equals marginal cost), the firm would shut down as price is less than AVC. The loss per unit of producing is distance AC. No contribution is made to fixed costs

If the firm shuts down production the loss per unit will equal the fixed cost per unit AB.

In the short-run, provided that the price is greater than or equal to P2, the business can justify continuing to produce

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