Example
Assume that a firm has fixed costs of $20,000, variable costs of 45,000 and revenue of 35,000. The firm is operating at a loss since total costs exceed total revenue. Nonetheless a manager may be tempted to continue to produce because he is earning sufficient revenue to pay his fixed costs and a portion of his variable costs. However, the proper course is to shut down. The shutdown loss is 20,000 while the operating loss is 30,000. The shutdown decision is a short-run decision. A firm that has shut down must decide whether to remain in the industry or exit the industry and seek profits elsewhere. The firm in the example will leave the industry unless it can reduce variable costs or increase revenue. Note that the level of fixed costs is irrelevant to the shutdown decision. If fixed costs were to be reduced to 10,000, the firm would still shut down because variable costs exceed revenue.
Read more about this topic: Shutdown (economics)
Famous quotes containing the word example:
“Our intellect is not the most subtle, the most powerful, the most appropriate, instrument for revealing the truth. It is life that, little by little, example by example, permits us to see that what is most important to our heart, or to our mind, is learned not by reasoning but through other agencies. Then it is that the intellect, observing their superiority, abdicates its control to them upon reasoned grounds and agrees to become their collaborator and lackey.”
—Marcel Proust (1871–1922)