<P> Another way to state the rule is that a firm should compare the profits from operating to those realized if it shut down, and select the option that produces the greater profit (positive or negative). A firm that is shut down is generating zero revenue and incurring no variable costs . However the firm still incurs fixed cost . So the firm's profit equals the negative of fixed costs or (- FC). An operating firm is generating revenue, incurring variable costs and paying fixed costs . The operating firm's profit is R - VC - FC . The firm should continue to operate if R - VC - FC ≥ - FC which simplified is R ≥ VC . The difference between revenue, R, and variable costs, VC, is the contribution toward offsetting fixed costs, and any positive contribution is better than none . Thus, if R ≥ VC then the firm should operate . If R <VC the firm should shut down . </P> <P> An implicit assumption of the above rules is that all fixed costs are sunk costs . When some costs are sunk and some are not sunk, total fixed costs (TFC) equal sunk fixed costs (SFC) plus non-sunk fixed costs (NSFC) or TFC = SFC + NSFC . When some fixed costs are non-sunk, the shutdown rule must be modified . As Besanko notes, to illustrate the new rule it is necessary to define a new cost curve, the average non-sunk cost curve, or ANSC . The ANSC equals the average variable costs plus the average non-sunk fixed cost or ANSC = AVC + ANFC . The new rule then becomes: if the price is greater than the minimum average costs, produce; if the price is between minimum average costs and minimum ANSC produce, and if the price is less than minimum ANSC for all levels of production, shut down . If all fixed costs are non-sunk, then (a competitive) firm would shut down if the price were below average total costs . </P> <P> A decision to shut down means that the firm is temporarily suspending production . It does not mean that the firm is going out of business (exiting the industry). If market conditions improve, due to prices increasing or production costs falling, the firm can resume production . Shutting down is a short - run decision . A firm that has shut down is not producing, but it still retains its capital assets; however, the firm cannot leave the industry or avoid its fixed costs in the short run . </P> <P> However, a firm will not choose to incur losses indefinitely . In the long run, the firm will have to decide whether to continue in business or to leave the industry and pursue profits elsewhere . Exit is a long - term decision . A firm that has exited an industry has avoided all commitments and freed all capital for use in more profitable enterprises . A firm that exits an industry earns no revenue but it incurs no costs, fixed or variable . </P>

When do you shut down in the short run