What is the difference between shutdown and going out of business

Select personalised ads. Apply market research to generate audience insights. Measure content performance. Develop and improve products.

List of Partners vendors. A shutdown point is a level of operations at which a company experiences no benefit for continuing operations and therefore decides to shut down temporarily—or in some cases permanently. It results from the combination of output and price where the company earns just enough revenue to cover its total variable costs.

At the shutdown point, there is no economic benefit to continuing production. If an additional loss occurs, either through a rise in variable costs or a fall in revenue, the cost of operating will outweigh the revenue. At that point, shutting down operations is more practical than continuing.

If the reverse occurs, continuing production is more practical. If a company can produce revenues greater or equal to its total variable costs , it can use the additional revenues to pay down its fixed costs, assuming fixed costs , such as lease contracts or other lengthy obligations, will still be incurred when the firm shuts down. When a company can earn a positive contribution margin , it should remain in operation despite an overall marginal loss.

A shutdown point can apply to all of the operations a business participates in or just a portion of its operations. The shutdown point does not include an analysis of fixed costs in its determination. It is based entirely on determining at what point the marginal costs associated with operation exceed the revenue being generated by those operations. Certain seasonal businesses, such as Christmas tree farmers, may shut down almost entirely during the off-season.

While fixed costs remain during the shutdown, variable costs can be eliminated. Fixed costs are the costs that remain regardless of what operations are taking place. This can include payments to maintain the rights to the facility, such as rent or mortgage payments , along with any minimum utilities that must be maintained.

Minimum staffing costs are considered fixed if a certain number of employees must be maintained even when operations cease. Variable costs are more closely tied to actual operations.

This can include but is not limited to, employee wages for those whose positions are tied directly to production, certain utility costs, or the cost of the materials required for production. The length of a shutdown may be temporary or permanent, depending on the nature of the economic conditions leading to the shutdown. For non-seasonal goods, an economic recession may reduce demand from consumers, forcing a temporary shutdown in full or in part until the economy recovers.

Figure 1. The Shutdown Point for the Raspberry Farm. The farm will lose less by shutting down. If the perfectly competitive firm faces a market price above the shutdown point, then the firm is at least covering its average variable costs.

At a price above the shutdown point, the firm is also making enough revenue to cover at least a portion of fixed costs, so it should limp ahead even if it is making losses in the short run, since at least those losses will be smaller than if the firm shuts down immediately and incurs a loss equal to total fixed costs. However, if the firm is receiving a price below the price at the shutdown point, then the firm is not even covering its variable costs. To summarize, if:. The average cost and average variable cost curves divide the marginal cost curve into three segments, as Figure 2 shows.

Figure 2. Profit, Loss, Shutdown. We can divide marginal cost curve into three zones, based on where it is crossed by the average cost and average variable cost curves.

We call the point where MC crosses AC the break even point. If the firm is operating where the market price is at a level higher than the break even point, then price will be greater than average cost and the firm is earning profits. If the price is exactly at the break even point, then the firm is making zero profits. If price falls in the zone between the shutdown point and the break even point, then the firm is making losses but will continue to operate in the short run, since it is covering its variable costs, and more if price is above the shutdown-point price.

However, if price falls below the price at the shutdown point, then the firm will shut down immediately, since it is not even covering its variable costs. First consider the upper zone, where prices are above the level where marginal cost MC crosses average cost AC at the zero profit point. At any price above that level, the firm will earn profits in the short run. If the price falls exactly on the break even point where the MC and AC curves cross, then the firm earns zero profits.

If a price falls into the zone between the break even point, where MC crosses AC, and the shutdown point, where MC crosses AVC, the firm will be making losses in the short run—but since the firm is more than covering its variable costs, the losses are smaller than if the firm shut down immediately. At any price like this one, the firm will shut down immediately, because it cannot even cover its variable costs.

To understand why this perhaps surprising insight holds true, first think about what the supply curve means.

A firm checks the market price and then looks at its supply curve to decide what quantity to produce. This rule means that the firm checks the market price, and then looks at its marginal cost to determine the quantity to produce—and makes sure that the price is greater than the minimum average variable cost.

As we discussed in the module on demand and supply, many of the reasons that supply curves shift relate to underlying changes in costs.

For example, a lower price of key inputs or new technologies that reduce production costs cause supply to shift to the right.

In contrast, bad weather or added government regulations can add to costs of certain goods in a way that causes supply to shift to the left. A shift in costs of production that increases marginal costs at all levels of output—and shifts MC upward and to the left—will cause a perfectly competitive firm to produce less at any given market price.

Conversely, a shift in costs of production that decreases marginal costs at all levels of output will shift MC downward and to the right and as a result, a competitive firm will choose to expand its level of output at any given price.

The following Work It Out feature will walk you through an example. To determine the short-run economic condition of a firm in perfect competition, follow the steps outlined below.

Use the data in the table below. If the price is exactly at the zero-profit point, then the firm is making zero profits. If price falls in the zone between the shutdown point and the zero-profit point, then the firm is making losses but will continue to operate in the short run, since it is covering its variable costs.

However, if price falls below the price at the shutdown point, then the firm will shut down immediately, since it is not even covering its variable costs. First consider the upper zone, where prices are above the level where marginal cost MC crosses average cost AC at the zero profit point. At any price above that level, the firm will earn profits in the short run. If the price falls exactly on the zero profit point where the MC and AC curves cross, then the firm earns zero profits.

If a price falls into the zone between the zero profit point, where MC crosses AC, and the shutdown point, where MC crosses AVC, the firm will be making losses in the short run—but since the firm is more than covering its variable costs, the losses are smaller than if the firm shut down immediately.

At any price like this one, the firm will shut down immediately, because it cannot even cover its variable costs. To understand why this perhaps surprising insight holds true, first think about what the supply curve means. A firm checks the market price and then looks at its supply curve to decide what quantity to produce. This rule means that the firm checks the market price, and then looks at its marginal cost to determine the quantity to produce—and makes sure that the price is greater than the minimum average variable cost.

Watch this video that addresses how drought in the United States can impact food prices across the world. Note that the story on the drought is the second one in the news report; you need to let the video play through the first story in order to watch the story on the drought.

As discussed in the module on Demand and Supply, many of the reasons that supply curves shift relate to underlying changes in costs. For example, a lower price of key inputs or new technologies that reduce production costs cause supply to shift to the right; in contrast, bad weather or added government regulations can add to costs of certain goods in a way that causes supply to shift to the left.

A shift in costs of production that increases marginal costs at all levels of output—and shifts MC to the left—will cause a perfectly competitive firm to produce less at any given market price. Conversely, a shift in costs of production that decreases marginal costs at all levels of output will shift MC to the right and as a result, a competitive firm will choose to expand its level of output at any given price.

To determine the short-run economic condition of a firm in perfect competition, follow the steps outlined below. Use the data shown in Table 8. Step 1. Determine the cost structure for the firm. For a given total fixed costs and variable costs, calculate total cost, average variable cost, average total cost, and marginal cost.

Follow the formulas given in the Cost and Industry Structure module. These calculations are shown in Table 8. Step 2. Determine the market price that the firm receives for its product.