What is Shutdown Point?

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Author: Sarthak Bhalerao

Table of Contents

  1. What is a Shutdown point?
  2. Understanding shutdown points
  3. Shutdown Point Diagram
  4. Types of Shutdown Points

What is a Shutdown point?

A shutdown point is a level of operation in which the company no longer benefits from continuing its operations and hence decides to shut down temporarily or permanently. The company no longer benefits from continuing production in the short run when the revenue from selling the product does not cover the cost of production. The shutdown point indicates that if the company continues production, it will keep on incurring higher losses. It occurs where marginal profit reaches a negative scale. 

Understanding shutdown points

A shutdown arises when price or average revenue falls below the average variable cost at the profit-maximizing output level. A shutdown point is usually a short-term position; however, in the long run, the firm shuts down and leaves the industry if its product price is less than the cost price. The shutdown point does not include an analysis of fixed cost in its determination. It determines at what point the marginal costs associated with operation exceed the revenue being generated by those operations.

The shutdown point has the following characteristics:

  • It is the output and price point where a firm is able to cover its variable cost
  • The average variable cost (AVC) is at its minimum point
  • It is where the marginal cost curve intercepts the average variable cost(AVC) curve

Shutdown point diagram

 

Where:

  • MC – Marginal Cost
  • ATC – Average Total Cost
  • AVC – Average Variable Cost
  • SP – Shutdown Price
  • BEP – Break-even Price

Types of Shutdown points

The duration of the shutdown may be temporary or permanent depending on the nature of the financial conditions of the company. For goods that are not essential, the demand can recede from customers, forcing them to shut down temporarily until the economy recovers. The demand may also go down due to changes in consumer preference. For instance, no one produced CRT televisions in the era of LED and OLED. Another reason for fluctuation could be their production frequency. For e.g., Apples are found all year round whereas mangoes are only found in summer.

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Sarthak Bhalerao

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