ECON1101 Chap.8 Profit, Shutdown and Exit
Profit, Shutdown and Exit
Profit, Shutdown and Exit turns cost curves into decisions for a price-taking firm. Price equals marginal revenue, so profit is maximised where price equals marginal cost on the rising part of the curve, and profit is (p − ATC) × q.
The chapter separates economic from accounting profit, then derives the short-run shutdown rule, produce if price covers average variable cost, and the long-run exit rule, stay if price covers average total cost, giving the firm’s supply curve as marginal cost above minimum AVC. Worked cases follow one firm from a $184 profit at a high price to a short-run loss at $20 that it should accept before exiting in the long run.
What this chapter covers
- 01
Price, marginal revenue and average revenue
- 02
The MR = MC profit rule
- 03
Profit as (p − ATC) × q
- 04
Economic versus accounting profit
- 05
The short-run shutdown price
- 06
The long-run exit price
Worked example · free
Profit, shutdown and exit prices for one firm
- 2Set p = MC: 20 − 8q + 1.5q² = 52 holds at q = 8, since 20 − 64 + 96 = 52.
- 1ATC(8) = 72/8 + 20 − 32 + 32 = $29.
- 1Profit = (52 − 29) × 8 = $184.
- 1Shutdown price = minimum AVC = $12; exit price = minimum ATC = $26.
Key terms
- Marginal revenue
- Marginal revenue is the extra revenue from selling one more unit, equal to the price for a price-taking firm.
- Economic profit
- Economic profit is total revenue minus explicit and implicit costs, including the owner’s opportunity costs.
- Shutdown price
- The shutdown price is the lowest point of average variable cost, below which a firm produces nothing in the short run.
- Sunk cost
- A sunk cost is a cost already committed that cannot be recovered, such as fixed cost in the short run.
- Normal profit
- Normal profit is zero economic profit, at which the owner earns exactly the return available elsewhere.
Profit, Shutdown and Exit FAQ
Why does a firm keep producing when it is making a loss?
In the short run fixed costs must be paid whether or not the firm produces. If revenue covers variable cost, producing shrinks the loss below the fixed cost it would lose by closing, so staying open is the better choice.
What is the difference between shutting down and exiting?
Shutting down is a short-run choice to produce nothing for a while while keeping the firm in the industry and paying fixed costs. Exiting is a long-run choice to leave the market altogether, when no fixed costs remain.
Why is economic profit smaller than accounting profit?
Economic profit subtracts implicit costs as well, such as the salary the owner gives up and the return the money invested could earn elsewhere. Accounting profit subtracts only costs that involve paying money.
Is the whole marginal cost curve the firm’s supply curve?
No. Only the part above minimum average variable cost counts. Below that price the firm shuts down and supplies nothing, so its short-run supply curve starts at the shutdown price.
How do I show profit or loss on a cost diagram?
Find the output where the price line meets marginal cost, read average total cost at that output, and draw a rectangle between the price and average total cost with that output as its width. It shows profit when price is above average total cost and loss when it is below.
Why does the firm set price equal to marginal cost rather than average cost?
Profit changes with each extra unit by the difference between the revenue it brings, the price, and the cost it adds, the marginal cost. Average cost tells you whether total profit is positive, but only the marginal comparison tells you whether one more unit raises or lowers it.
Exam move
Work one cost-table problem end to end every revision day: find output where marginal cost reaches the price, compute profit, then apply the shutdown test against average variable cost and the exit test against average total cost. Draw the matching diagram with the profit or loss rectangle. Keep a short list of implicit costs so that every economic profit question starts by naming them.
Keep the two cut-offs side by side on your summary sheet, shutdown at minimum average variable cost and exit at minimum average total cost, with one sentence explaining why fixed cost matters only in the short run.
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