Social Sciences and History / Unit 13 SSH 1234 worked example, 60 to 90 seconds
Zero-Profit Point and Shutdown Point: Deciding What to Do
The idea
The exam gives a competitive firm's price against its average cost and average variable cost and asks what it should do, and the anchor's two points decide. The zero-profit point, or break-even point, is where the marginal cost curve crosses the average cost curve at the minimum of average cost; at that price the firm earns zero economic profit. The shutdown point is where marginal cost crosses average variable cost at its minimum. If price is below average variable cost at the profit-maximizing quantity, shut down immediately. If price is above average variable cost but below average cost, keep producing in the short run, because revenue covers variable cost and some of the sunk fixed cost, and exit in the long run. If price is above average cost, produce and profit.
In practice
Given "price twelve, average cost ten, average variable cost seven", produce; profit. Given "price nine, average cost ten, average variable cost seven", produce now, exit later. Given "price six, average cost ten, average variable cost seven", shut down now. Ask two questions in order: does price cover variable cost, and does it cover all cost.
Where people slip
The trap is shutting down at the first loss; a loss smaller than fixed cost is the better short-run choice. The second trap is calling zero profit failure; at the zero-profit point the owner earns the normal return.
Your place on the trail
Every lesson rests on earlier ones and opens later ones. Tap any to jump.
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