Operating at a loss can be better than closing temporarily.
A short-run shutdown temporarily stops production; exit leaves the activity and its future commitments. The choice compares the best feasible operating result with closure, using costs that can actually be avoided. In the simple model where fixed cost remains payable and only variable cost is avoided, operating is preferable if its revenue covers variable cost and contributes towards fixed cost. At the best operating output, TR >= TVC is equivalent to price/AR >= AVC in a single-price model, with equality giving indifference before other effects. Long-run exit examines future avoidable costs, opportunity costs and alternatives. Past unrecoverable spending alone is not a reason to continue.
- Short-run choice
- Shutdown means temporarily stopping production. Compare closure with the best feasible operating plan: the best option the firm can actually carry out.
- Costs saved by closing
- Avoidable costs disappear if the firm closes; unavoidable costs must still be paid. In the simple model, closing saves variable costs but leaves the fixed payment unchanged.
- Long-run choice
- Exit means leaving the activity. Future commitments, such as renewing a lease, may then be avoidable even though this week's payment cannot be escaped.
Read the shutdown condition
Totals
TR means total revenue; TVC means total variable cost. If only TVC is saved by closing, operating with TR greater than TVC contributes towards the fixed payment and reduces the loss. At TR = TVC, operation and closure tie before other effects.
Per-unit notation
AR is average revenue per unit; AVC is average variable cost per unit. At one selling price, AR equals price (P). Dividing TR >= TVC by a positive operating quantity gives P = AR >= AVC under these assumptions.
Model limits
Closure penalties, restarting costs, reputation and other avoidable commitments can change the comparison. Not all fixed costs are sunk: a future fixed payment may still be avoidable.
Scope
A diagrammatic shutdown analysis is not required by the current syllabus.
| Option | Revenue | Avoidable cost | Unavoidable cost | Profit |
|---|---|---|---|---|
| Best operation | 80 | 60 | 35 | -15 |
| Temporary closure | 0 | 0 | 35 | -35 |
Worked example: Lose $15 by opening or $35 by closing?
At its best feasible operating plan this week, a shop earns total revenue of $80, incurs avoidable variable cost $60 and pays $35 fixed cost whether open or closed. There are no other closure costs or benefits.
- Operating gives profit 80 - 60 - 35 = -$15. Closing gives -$35 because the fixed payment remains.
- Operating contributes $20 towards the unavoidable payment, so it loses less than closing this week. A loss alone is not sufficient reason to shut down.
- If every feasible operating plan has revenue below its avoidable cost, closure gives a better result under this simple comparison. Equality can create a tie.
- Next month's lease renewal could be avoidable. That longer-run choice must use future costs and alternatives, not mechanically repeat this week's answer.
Watch out for this
A firm must shut down whenever total revenue is below total cost.
It may reduce its loss by operating if it covers avoidable cost. Specify what closure saves and compare the best operating plan.
Check your understanding
Under the stated shop example, what is financially preferable this week?
- Close, because any loss is unacceptable.
- Both are equal because fixed cost is unchanged.
- Operate, losing $15 rather than $35.