KNOW

UNDERSTAND

The price at which a firm will breakevenThe price at which a firm will/should shut down.

THINKING – MANAGING SELF – PARTICIPATING AND CONTRIBUTING - RELATING TO OTHERS – USING LANGUAGE, SYMBOLS and TEXT

LEVEL 3 ECONOMICS AS3.1 Understand marginal analysis and the behaviour of firms

Understanding Economics Chapt 7, P67-74

Breakeven and Shut Down Point

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 cover at least its variable costs it should shutdown.

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.

PRICE $COST $REVENUE $

QUANTITY

ATC

AVC

MC

Break even point – An example

10

300

If this firm is receiving a price of $10 and is selling a quantity of 300Its total revenue will be?

PRICE $COST $REVENUE $

QUANTITY

ATC

AVC

MC

Break even point – An example

10

300

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

PRICE $COST $REVENUE $

QUANTITY

ATC

AVC

MC

Break even point – An example

10

300

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?

PRICE $COST $REVENUE $

QUANTITY

ATC

AVC

MC

Break even point – An example

10

300

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

PRICE $COST $REVENUE $

QUANTITY

ATC

AVC

MC

Break even point – An example

10

300

So we have a Total Revenue (TR) of $3000 and a Total Cost (TC) of $3000 at an output of 300 units. TR – TC = Profit OR $3000 - $3000 = 0 or BREAK EVEN

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

PRICE $COST $REVENUE $

QUANTITY

ATC

AVC

MC

SHUTDOWN point – An example

10

300

This firm is receiving a price of $8 and is selling a quantity of 300Its total revenue will be $8 x 300 = $2400Its total variable costs will be $8 x 300 = $2400

8

PRICE $COST $REVENUE $

QUANTITY

ATC

AVC

MC

SHUTDOWN point – An example

10

300

This firm is receiving a price of $8 and is selling a quantity of 300Its total revenue will be $8 x 300 = $2400Its total variable costs will be $8 x 300 = $2400

It should SHUTDOWN, there is no sense in opening the doors.

8

PRICE $COST $REVENUE $

QUANTITY

ATC

AVC

MC

SHUTDOWN point – An example

10

300

What does the shaded area in the diagram represent?

8

PRICE $COST $REVENUE $

QUANTITY

ATC

AVC

MC

SHUTDOWN point – An example

10

300

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.

8

Hopefully you are clear about Break Even and Shutdown point?

B/E is where P = AC

SHUTDOWN is where P = AVC

Feel free to review these slides again if you need to. If you are ready to move on close this slide show and go to the next step in the lesson.