Test Your Knowledge: Shutdown Rule (P < AVC) Questions & Answers

📚 Quick Study Guide

• 🔍 The Shutdown Rule states a firm should cease production in the short run if the market price is less than the average variable cost ($P < AVC$).
• 📉 AVC represents the firm's variable costs (like labor and materials) divided by the quantity of output: $AVC = \frac{TVC}{Q}$.
• 💰 If $P < AVC$, the firm is losing more money by producing than by shutting down temporarily, as it cannot even cover its variable costs.
• ⏱️ The Shutdown Rule is a short-run decision. In the long run, a firm will exit the industry if the price is less than the average total cost ($P < ATC$).
• 💡 A firm that shuts down still incurs fixed costs (like rent) but avoids additional variable costs.
• 📊 Graphically, the firm should shut down if the price is below the minimum point on the AVC curve.
• 📝 The break-even point is where price equals minimum average total cost (ATC). Shut down point is where Price equals minimum average variable cost (AVC).

Practice Quiz

1. Which of the following conditions indicates that a firm should shut down in the short run?

   1. Price is greater than average total cost.
   2. Price is greater than average variable cost.
   3. Price is less than average total cost.
   4. Price is less than average variable cost.

2. What does AVC stand for in the Shutdown Rule?

   1. Average Value Calculation
   2. Average Variable Cost
   3. Accounting Variable Cost
   4. Adjusted Value Cost

3. If a firm shuts down temporarily, what type of costs does it still have to pay?

   1. Variable Costs
   2. Fixed Costs
   3. Marginal Costs
   4. Opportunity Costs

4. The Shutdown Rule ($P < AVC$) is applicable in which time frame?

   1. Long Run
   2. Medium Run
   3. Short Run
   4. Very Long Run

5. What happens to a firm when the market price equals the minimum point on the AVC curve?

   1. The firm makes zero economic profit.
   2. The firm breaks even.
   3. The firm is indifferent between producing and shutting down.
   4. The firm maximizes profits.

6. Assume a firm has total variable costs of $500 and produces 100 units. If the market price is $4, should the firm shut down based on the Shutdown Rule?

   1. No, because P > AVC.
   2. Yes, because P > AVC.
   3. Yes, because P < AVC.
   4. No, because P = AVC.

7. At what point on the AVC curve is the Shutdown point determined?

   1. The maximum point
   2. The inflection point
   3. The minimum point
   4. Any point above the ATC curve