The Shutdown Point and Average Variable Cost

When a firm encounters its shutdown point, it means that the firm is no longer able to cover its variable costs and is better off ceasing operations in the short run. In other words, the firm is incurring losses that are greater than its variable costs. The shutdown point is an important concept in economics and helps determine the firm's short-run decision-making.

Understanding Average Variable Cost (AVC)

Before we delve into the shutdown point, let's first understand what average variable cost (AVC) is. AVC is the variable cost per unit of output. It is calculated by dividing the total variable cost (TVC) by the quantity of output produced. Mathematically, AVC = TVC / Q, where Q represents the quantity of output.

Explanation of the Correct Answer (Option B)

The correct answer to the question is option B, which states that the shutdown point occurs when the average variable cost equals the price at the profit-maximizing level of output. This is because the firm can no longer cover its variable costs with the revenue generated from selling its output.

Why Average Variable Cost?

The shutdown point is determined by comparing the firm's revenue with its costs. The revenue is determined by multiplying the price per unit of output by the quantity of output sold. The costs can be divided into fixed costs and variable costs. Fixed costs are incurred regardless of the level of output, while variable costs vary with the level of output.

Shutdown Point Condition

The shutdown point occurs when the firm's revenue is not sufficient to cover its variable costs. At this point, the firm is better off shutting down and minimizing its losses. In other words, the firm should not produce any output if the revenue generated from selling that output is less than the variable costs incurred to produce it.

Relationship between AVC and Shutdown Point

The average variable cost (AVC) plays a crucial role in determining the shutdown point. When AVC equals the price at the profit-maximizing level of output, it means that the firm is just covering its variable costs with the revenue generated. There is no surplus to cover any fixed costs, and the firm is at the break-even point.

If AVC is greater than the price, it means that the firm is incurring losses greater than its variable costs. In this scenario, the firm should shut down and minimize its losses. If AVC is less than the price, it means that the firm is making a profit that exceeds its variable costs. The firm should continue producing output as long as it is profitable.

Conclusion

In conclusion, the shutdown point occurs when the firm is no longer able to cover its variable costs with the revenue generated from selling its output. The average variable cost (AVC) equals the price at the profit-maximizing level of output, indicating that the firm is just covering its variable costs. Any further reduction in output would not contribute to covering any fixed costs and would result in losses. Therefore, option B, which states that the shutdown point occurs when the average variable cost equals the price at the profit-maximizing level of output, is the correct answer.

Shutdown point is the point which indicates that the firm has to shutdown if the business goes on like this.
According to behavioural principles, a firm has to shutdown when it is not even able to cover it's variable cost. Hence shutdown point will be average variable cost equal to price.