Answer to Question #235807 in Microeconomics for Mozahidul Islam

Question

What is shut down condition of a firm? Derive the shut down condition mathematically
and show graphically with explanation.

Answer 1

Solution:

The shutdown condition of a firm refers to a condition that the firm will want to produce if the price it receives for its output is at least as large as its average variable cost of production at the profit-maximizing quantity of output.

If the price is below the average variable cost, then the firm should temporarily shut down since it will incur no economic benefit in continuing with production due to extreme losses. It occurs when the marginal profit becomes negative.

 

This is depicted by the below graph:

 

 

In the diagram above, the firm will be willing to produce at prices greater than or equal to P_min, since this is the minimum value of the average variable cost curve. At prices below P_min, the firm will decide to shut down and produce a quantity of zero instead.