A shutdown point is defined as the level of operations at which a particular company experiences no benefit for continuing the operations and thus, they decide to shut down, even though temporarily. While in some cases the organizations once they reach this no profit and no loss zone decide to close their organization permanently. Here the common only earns the revenue to cover up their variable cost. That means the companys marginal revenue is equal to the variable cost that is to be covered. In this case, the companys marginal or the minimum profit have turned negative.
What is the Shutdown Point in Economics?
This is a point at which a businessman thinks that there is no benefit for continuing their business operations. Thus, they finally decide to shut down the business if temporarily or maybe permanently, this point is determined as the shut-down point. This situation could crop up for the output and the price or where the business earns only the revenue, merely bearing to cover the total variable cost. This shutdown point occurs at a time when the marginal profit of the business reaches a negative scale.
At the shutdown point, there is no economic benefit to continue the production, if there is an additional loss either a rise in variable costs or adecrease in the revenue, the cost of operations might cross the revenue. In this situation, shutting the business down will only be the better choice rather than continuing it.
What is the Shutdown Point of a Firm?
A firm may earn losses if they continue to operate, so why cannot the firm avoid losses by only shutting down and not producing their goods or services at all. The answer is that shutting down can reduce variable costs to zero, but in the short run, the business is already committed to payingits fixed costs. As a result, if the firm produces a nil quantity, it would still make losses as it would still need to pay for its fixed costs. Therefore, when a firm is experiencing shortage or losses, it must answer a question: should it continue producing, or should it completely shut down?
How the Shutdown Point Works
At the shutdown point, there will be no economic benefit to continue their production. If there is an additional loss, either through a rise in the variable costs or a fall in the total revenue earned, the cost of operating will gradually outweigh the revenue.
At that point in time, shutting down the operations is more practical than continuing its business. If the reverse occurs, then continuing production would be more practical. If a company produces revenues that are greater or equal to the variable costthen it can use the additional revenues to pay down the fixed costs, assuming that the fixed cost like the lease contracts or other lengthy obligations, will be incurred when the firm shuts down. When a company can earn a positive contribution margin, this should remain in operation despite the marginal loss.
Types of Shutdown Points
The length of a shutdown can be temporary or permanent, this depends on the nature of the economic conditions which is leading to the shutdown. For the non-seasonal goods, in an economic recession,this may reduce the demand from the consumers, after forcing a temporary shutdown (partially or totally) until the economy recovers from this.
Yet at other times, the demand dries up completely for the changing consumer preferences, also for the technological upgrade. For example, nobody produces the cathode-ray tube (CRT) televisions or computer monitors any longer, and thus this would be a losing prospect to open a factory such as these days to produce the same.
Other businesses also may experience the fluctuations or produce some goods year-round, while others are merely produced seasonally. For example, the Cadbury chocolate bars are produced year-round, while the Cadbury Cream Eggs are considered as a seasonal product. The main operations will be focused on the chocolate bars, which may remain operational year-round, while the cream egg operations will have to go through periods of a shutdown during the off-season as well.