The correct answer is: A firm encounters its ‘shutdown point’ when average variable cost equals price at the profit-maximizing level of output.
A firm’s shutdown point is the point at which it is better for the firm to shut down production and incur its fixed costs than to continue producing and incur both its fixed and variable costs. This occurs when the price of the firm’s output is less than its average variable cost.
Average variable cost is the total variable cost divided by the quantity of output produced. Variable costs are costs that vary with the level of output, such as the cost of raw materials and labor. Fixed costs are costs that do not vary with the level of output, such as the cost of rent and equipment.
When the price of the firm’s output is less than its average variable cost, the firm is losing money on each unit it produces. In this case, the firm would be better off shutting down production and only incurring its fixed costs. This is because the firm’s fixed costs are sunk costs, which are costs that have already been incurred and cannot be recovered.
For example, suppose a firm has a fixed cost of $100 and a variable cost of $5 per unit. If the price of the firm’s output is $4 per unit, the firm will lose $1 per unit it produces. In this case, the firm would be better off shutting down production and only incurring its fixed cost of $100.
It is important to note that the shutdown point is not the same as the break-even point. The break-even point is the point at which the firm’s total revenue equals its total cost. At the break-even point, the firm is not making a profit or a loss. The shutdown point, on the other hand, is the point at which the firm is better off shutting down production.