Principles of Microeconomics / Unit 7 MIC 0615 worked example, 60 to 90 seconds
The Shutdown Test
The idea
Given a price, find the marginal-rule quantity and the average variable cost there, variable cost over output. If price is at or above average variable cost, operate at that quantity: the loss is smaller than the fixed cost. If price is below average variable cost, shut down: the loss is the fixed cost and nothing more. Confirm by comparing the two losses directly, the operating loss against the fixed cost.
In practice
Worked example: at twenty-two dollars the farm's rule gives six flats, and average variable cost there is ninety over six, fifteen dollars. Twenty-two exceeds fifteen, so it operates, losing eighteen rather than sixty. At twelve dollars the rule gives four flats, and average variable cost is fifty-four over four, thirteen fifty. Twelve is below thirteen fifty, so it shuts down, losing sixty rather than the sixty-six it would lose growing four.
Where people slip
Two cautions. Do not compare price with average total cost for this decision; at twenty-two dollars price is below total cost and operating is still right. And shutting down does not erase the fixed cost; it is the smallest loss available, not a return to zero.
Your place on the trail
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