Th3.3: Short-run and Long-run Shut-down Points

Question 1

When a business is making a loss, it may not necessarily be the best decision to shut down straight away - what does this depend on?

Answer 1

depends on the average variable cost

Question 2

If AVC < AR then…

Answer 2

firms should continue production - each good they make will generate more revenue than it cost for them to make it, and so this will help reduce the size of the loss by covering some of the fixed cost - should only shut down when their fixed costs increase

Question 3

However, if AVC > AR…

Answer 3

then producing more goods will increase the loss. as a result they should leave the industry immediately

Question 4

In the long run, what do firms need to do?

Answer 4

make at least normal profit for them to stay in the industry

Question 5

What should firms do in the short run?

Answer 5

produce as long as their revenue covers their variable costs

Question 6

Hence the short run shut-down point is…

Answer 6

where AVC = AR

Question 7

Why do firms tend to produce on the short run point even though it doesn’t affect their losses?

Answer 7

as they do not want to let go of their workers or let down customers

Question 8

Refer to PP

Look at Graph 33. In the diagram, the business produces in…

Answer 8

the short run and will continue to do so

Question 9

Refer to PP

Look at Graph 33. Where will they produce if they are profit maximising?

Answer 9

where MR = MC at the output Q1

Question 10

Refer to PP

Look at Graph 33. This will mean their price, P1, will be determined by… and their costs, C1, will be determined by…

Answer 10

the AR curve at this level of output, and their costs determined by the AC curve

Question 11

Refer to PP

Look at Graph 33. What does the shaded area represent?

Answer 11

the loss

Question 12

Refer to PP

Look at Graph 33. Why will they produce in the short run?

Answer 12

their AVC cost is only C2 and AR > AVC