When is it optimal for a firm to shut down? Explain the circumstances and time horizon...

When is it optimal for a firm to shut down? Explain the circumstances and time horizon relating to this decision.

Can you please explain in detail

Expert Solution

It can be mentioned that the optimal level for a firm to shutdown is when the average variable cost is greater than the price or AVC>P

The reason behind this is that in the short run which is the time horizon here if it is not able to recover even the variable cost then even there is an operating loss along with that of fixed cost and there is no chance of recovering of the the capital at any unit of production and that is the reason why it is optimal to shut down. Now consider if the price is greater than the average variable cost but less than the average cost and in this time the form need not shut down because it will recover variable cost and also part of the fixed cost so at a particular quantity continuously if businesses done then because the fixed cost is constant the total cost can be recovered at some level of output so that you will be profitable at a point of time on the hole and that is the reason why the firm should shut down only when the average variable cost is greater than the price and in the short run

Rahul Sunny answered 2 years ago

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