Breakeven and shutdown
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  • 1. LEVEL 3 ECONOMICS AS3.1 Understand marginal analysis and the behaviour of firmsUnderstanding Economics Chapt 7, P67-74Breakeven and Shut Down Point The price at which a firm will breakeven The price at which a firm KNOW will/should shut down.  That when a firms Total Revenue is equal to its Total Economic Costs then it will breakeven.  When a firm receives a price that will not UNDERSTAND cover at least its variable costs it should shutdown. THINKING – MANAGING SELF – PARTICIPATING AND CONTRIBUTING - RELATING TO OTHERS – USING LANGUAGE, SYMBOLS and TEXT
  • 2. Breakeven point• This is the point where price is equal to average cost or P=AC• At this price the firm is covering all of its economic costs (recall this is accounting cost plus opportunity cost)• In economics when a firm is at a breakeven point it is said to be earning a normal profit.
  • 3. Break even point – An examplePRICE $COST $ MCREVENUE $ ATC 10 AVC 300 QUANTITY If this firm is receiving a price of $10 and is selling a quantity of 300 Its total revenue will be?
  • 4. Break even point – An examplePRICE $COST $ MCREVENUE $ ATC 10 AVC 300 QUANTITY You should know that Total Revenue is equal to price times quantity (P x Q)? In this case that is $10 x 300 units = $3000
  • 5. Break even point – An examplePRICE $COST $ MCREVENUE $ ATC 10 AVC 300 QUANTITY You should also see that in this case as the price (or cost) of $10 cuts the ATC (AC) curve then $10 is also the average cost at an output level of 300 units?
  • 6. Break even point – An examplePRICE $COST $ MCREVENUE $ ATC 10 AVC 300 QUANTITY You should know that Total Cost is equal to cost times quantity (C x Q)? In this case that is $10 x 300 units = $3000
  • 7. Break even point – An examplePRICE $COST $ MCREVENUE $ ATC 10 AVC 300 QUANTITYSo we have a Total Revenue (TR) of $3000 and a Total Cost (TC) of $3000 at anoutput of 300 units. TR – TC = Profit OR $3000 - $3000 = 0 or BREAK EVEN
  • 8. Shutdown point• Recall that Total Cost =FC + VC• If a firm can’t even receive a price to cover the VC of producing a good then it should shutdown.• In this case though it will still have to pay its fixed costs• At any price point between shutdown (above AVC) and breakeven at least the firm will receive a contribution to cover FC so it will continue to operate. SHUTDOWN is where P = AVC
  • 9. SHUTDOWN point – An examplePRICE $COST $ MCREVENUE $ ATC 10 AVC 8 300 QUANTITY This firm is receiving a price of $8 and is selling a quantity of 300 Its total revenue will be $8 x 300 = $2400 Its total variable costs will be $8 x 300 = $2400
  • 10. SHUTDOWN point – An examplePRICE $COST $ MCREVENUE $ ATC 10 AVC 8 300 QUANTITY This firm is receiving a price of $8 and is selling a quantity of 300 Its total revenue will be $8 x 300 = $2400 Its total variable costs will be $8 x 300 = $2400 It should SHUTDOWN, there is no sense in opening the doors.
  • 11. SHUTDOWN point – An examplePRICE $COST $ MCREVENUE $ ATC 10 AVC 8 300 QUANTITY What does the shaded area in the diagram represent?
  • 12. SHUTDOWN point – An examplePRICE $COST $ MCREVENUE $ ATC 10 AVC 8 300 QUANTITY What does the shaded area in the diagram represent? If you identified this area as total FC at output 300 you are right! So you will see that at the Shutdown point of $8.00 the firm is not covering any of its FC. At any price between $8 and $10 it will at least be able to pay off some of its Fixed Costs (FC) so it makes sense to keep operating. At least in the short term and until the price in the market improves.
  • 13. Hopefully you are clear about Break Even and Shutdown point? B/E is where P = AC SHUTDOWN is where P = AVCFeel free to review these slides again if you need to. If you areready to move on close this slide show and go to the next stepin the lesson.