The point where price equals the minimum of the average variable cost of a firm in the short run is called the:
Multiple Choice
A shutdown point.
B break-even point.
C profit-maximizing point.
D revenue-maximizing point.
The correct answer and explanation is:
The correct answer is A. shutdown point.
In microeconomics, the shutdown point is the point at which a firm is indifferent between continuing to operate or temporarily shutting down in the short run. This occurs when the price of the good or service equals the minimum of the average variable cost (AVC). At this point, the firm’s revenue is exactly sufficient to cover its variable costs, but it is not able to cover its fixed costs.
When a firm operates below this price level, it will not be able to cover even its variable costs, which means it would incur a loss greater than if it ceased production entirely. In the short run, firms still have fixed costs that need to be paid even if they stop production, so as long as the firm can cover its variable costs, it may continue operating to minimize losses. However, if the price falls below the minimum AVC, the firm will shut down because continuing operations would increase losses beyond the fixed costs that still need to be paid.
At the shutdown point, the firm’s total revenue just equals its total variable costs, so it would not lose any more money by ceasing production. This point represents the minimum level of output the firm can produce while still covering its variable costs in the short run.
It is important to note that the shutdown point is not necessarily the point of long-run profitability or sustainability, but simply the threshold for continuing operations in the short run. The break-even point (option B) is the price at which a firm earns zero economic profit, covering both fixed and variable costs, while the profit-maximizing point (option C) is the point where marginal cost equals marginal revenue.