SHORT RUN: - Short run is a period of time in which a firm has some fixed costs which does not

vary with
the change in output of the firm. The change only takes place in variable factors in the short period the
number of firms remains the same in the industry. The firm sells the product at the prevailing price in
the market. Because under perfect competition no single firm can affect the price of the market.

I. Shut Down Situations:

Under perfect competition, a firm is a price taker i.e. the price is given to the firm. In the market, the
price is determined by the forces of demand and supply.

Given the price the firm can maximize supernormal profits, break even, minimize losses or shut down.

Thus, shut down point occurs when the price is so low that it cannot pay the fixed costs. The losses are
incurred and are equal to fixed costs.

The price covers the AVC. There are two shut down situations as:

1. When the firm decides to shut down.

2. When the firm actually shuts down.

1st Case: When the Firm Decides to Shut Down

This situation occurs when the price line passes through the minimum point of the AVC curve. It is
shown in figure 13. In this diagram, we see that at price OP, equilibrium is at point E where MR = MC.
The slope of MC is greater than zero. The firm sells OX units of output.

The loss in this situation is calculated as:

Loss per unit

= Cost per unit – Revenue per unit
= CX – EX = CE
Total Losses
= Loss per unit X Equilibrium Output
= CE X OX
= Shaded Rectangle (ACEP)
= Fixed Costs
Thus the firm decides to shut down at this point.
2nd Case: When the Firm Actually Shuts Down:

The prices below OP, the firm shuts down as losses are more than the fixed costs. The firms will not be
able to cover even AVC. This fact is clear from figure 14.

In figure 14, when price falls to OP, below the shutdown point, Equilibrium takes place at point E. Losses
which are incurred are equal to BE per point.
Total Losses
= Total Rectangle (ABEP)
= Shaded Rectangle ABCD + rectangle DCEP
= TFC + some part of TVC.
Since, losses are more than TFC, the firm shuts down its unit.
4. SHUT DOWN CASE
Definition: - If the market price is smaller than average variable cost, it will be better for a one firm to
close down the business to minimize the loss.
Explanation: - It is assumed that market price is OP. The firm is in equilibrium position at the point "M"
where MC = MR. The firm sells OK output but total cost is OPNK. The loss is OPNK - ORMK = RPNM.

So it will be better for a one firm to close down the business to minimize the loss. Because the firm is
not even covering the average variable cost.

Short Run Shut Down:

The price taker firm in the short-run minimizes losses by closing it down if the market price is less than
average variable cost. The shut down position of a Competitive firm is explained with the help of a
diagram.

In this figure (15.6) we assume that the market price is OP. The firm, is in equilibrium at point Z where
MR = MC. The firm produces OK output and sells at OP unit cost. The total revenue of the firm is equal
to the area OPZK. Whereas .the total cost producing OK output is OTFR.

The firm is suffering a net loss of total fixed cost equal to the area PTFZ. The firm at point Z is just
covering average variable costs.

If the price falls below Z, the competitive firm will minimize its losses by closing down. There is no level
of output which the firm can produce and realize a loss smaller than its fixed costs. It is therefore a
shutdown point for the firm. Operate When Price is > average variable cost.