Question

In: Economics

What is the rationale for a firm under perfect competition to shut down and to exit?...

What is the rationale for a firm under perfect competition to shut down and to exit? Please provide an example.

Solutions

Expert Solution

The shutdown point is called the intersection of the average variable cost curve and the marginal cost curve, which indicates the level at which the company will lose sufficient revenue to offset its variable costs. When the reasonably profitable company faces a market price above the shutdown point, the company can then at least meet its average operating costs.

The company still makes enough sales at a price above the shutdown point to cover at least a portion of the fixed costs, and it can coast on even though it makes losses in the short term, because at least those losses would be lower than if the company suddenly shuts down and creates a loss equal to the overall fixed costs.

However, if at the closure stage the business offers a offer below the mark, then the company doesn't even cover its variable costs. Staying open in this situation makes the company's losses higher, and should be shut down immediately.

Unless the selling price is equal to the average cost at the profit-maximizing production level, otherwise the business can make zero profits. They name the point where the marginal cost curve transcends the average cost curve, the break-even point at the bottom of the average cost curve. When the market price that a reasonably competitive firm faces at the profit-maximizing quantity of product is below average variable cost, then the firm will immediately shut down operations. When the market price facing a reasonably competitive business is above average variable cost but below average cost, then the business will continue to grow in the short term, but exit in the long term. We name the point where the marginal cost curve traverses the shutdown point of the typical variable cost curve.


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