What is the Shutdown Price?
The shutdown price helps businesses decide whether to keep producing or stop operations. It represents the Average Non-Sunk Cost (ANSC), which includes costs that can be avoided if production stops.
Knowing this number helps businesses make smart decisions and potentially save money. If the market price falls below your shutdown price, continuing production would only increase your losses.
How to Calculate Shutdown Price
Formula:
[\text{Shutdown Price} = \text{Average Variable Cost} + \text{Average Non-Sunk Fixed Cost}]
Where:
- Average Variable Cost (AVC) is the average cost that changes with production levels
- Average Non-Sunk Fixed Cost (ANFC) is the portion of fixed costs that can be avoided by stopping production
Calculation Example
Given:
- Average Variable Cost: $100
- Average Non-Sunk Fixed Cost: $120
Calculation:
[\text{Shutdown Price} = 100 + 120 = 220]
The result is $220.
The shutdown price is $220. If the market price of your product falls below $220, it would be financially smarter to stop production.
Understanding the Components
| Cost Type | Description | Example |
|---|---|---|
| Variable Costs | Costs that change with output | Raw materials, direct labor |
| Non-Sunk Fixed Costs | Fixed costs avoidable by stopping | Short-term leases, temporary staff |
| Sunk Costs | Fixed costs that cannot be avoided | Long-term contracts, past investments |
Key Insights
- Only non-sunk costs matter for the shutdown decision
- Sunk costs are irrelevant because they're already committed
- Operating below shutdown price increases losses
- Operating above variable cost but below shutdown price may still make sense short-term if you can cover some fixed costs
Understanding the shutdown price is a valuable tool for any business, helping you pinpoint when continuing production becomes financially unwise.