Define a firm's shutdown point, and explain it intuitively using an example

A firm's shutdown point occurs when the price they receive on each product is equal to its average variable cost. In the short run (when at least one factor of production is fixed), the firm will reduce its losses by closing production, when price is below this point.
Intuitively, the average variable cost represents the cost of producing each unit, just in terms of costs which vary with output. Let's consider Primark's recent closing of stores due to lower customer levels in the worldwide coronavirus pandemic. Each Primark shop has variable costs in things like electricity and wages paid to their staff. If the revenue they receive for each product (the price) is less than the cost it incurs in the store, then Primark can reduce their losses by completely shutting down shop and lowering their output to zero; this means their variable costs also fall to zero. Therefore, at any price below AVC, the firm will shut down. However, shutdown points are ONLY feasible in the short run. Remember that the definition of the short run means at least one factor of production for Primark is fixed; here, no matter if the store is shut, Primark has to pay rent for the building. Therefore, the firm still makes a loss based on its fixed cost even when shut down, and must eventually reopen and prevent these losses, or close permanently.

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Answered by Eden P. Economics tutor

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