Use A Graph To Explain The Concept Of Shut Down

The main aim of a firm is to reach profit maximization which takes place when marginal cost is equal to the marginal revenue (MC=MR). Profit maximization or the breakeven point is a desirable place for firms to be in as it is the point where it is productively and allocatively efficient. The firm is still making normal profit while covering all its costs.

In the short run, average variable cost must be covered if the firm is to continue in the business. The space above the breakeven point is abnormal profit and supernormal profit above the breakeven point. The firm can cover all of their average variable cost and still make a lot of profit. The space below the breakeven point but above the shut down point is subnormal profit where the firm makes fewer profit than normal profit which means that the firm can still cover the average variable cost but are not making any normal or supernormal profit.

When a company cannot cover average variable cost, a company will reach a shut down point. The shut down point takes place in the short run (when at least one variable is fixed) where the company stops its production but does not completely exit the industry. The company still needs to pay the fixed cost but it does not need to pay for the variable cost for example the labor. Shut down usually takes place when one of the factors of production is scarce. For instance; Thailand exports technology used in the production of cars to Japan. However, due to the floods in Thailand, Thailand could not export the technology. Thus, the car companies in Japan reached shut down point.