Explain the factors a profit-maximising firm will take into account when deciding whether to shut down or to carry on operating, both in the short run and in the long run

AQA A-Level Economics Paper 1 June 2019

Explain the factors a profit-maximising firm will take into account when deciding whether to shut down or to carry on operating, both in the short run and in the long run. (15 marks)

1. The short-run shutdown condition is AR < AVC.
2. In the short-run, at least one factor of production is fixed, such as the rent for a factory or office. 
3. Then, in the short-run, a firm would choose to shut down if average revenue is lower than average variable cost (AR < AVC). 
4. We can make a reasonable assumption that a firm would not be able to recover its fixed costs (such as its rent) if it chooses to shut down.
5. This means that they would not take its fixed costs into account regardless of whether they shut down or continue to operate. 
6. This means that if they continue to operate, they will aim to make average revenue that exceeds their average variable costs. 
7. If they do this, they can pay money towards their fixed costs, which will eventually be cleared.
8. Then, in the long run, where thee are no fixed costs, the firm would be able to make a supernormal profit.
9. For example, if a firm is making AR: £1000, AVC: £500 and AFC: £600, it would choose not to shut down. This is because, if it chooses to shut down, it will have wasted £600 on fixed costs.
10. If it continues to operate , it would make £500 per unit which can be used to pay off the fixed costs. 

1. The long-run shutdown condition is AR<AC.
2. In the long-run, all factors of production are variable.
3. In the long-run, a firm would choose to shut down if they fail to make normal profits. 
4. Normal profit is when average revenue equals average cost.
5. Normal profit is not the same as accounting profits because the way that average costs are calculated, is different.
6. Average costs in economics includes both explicit costs such as raw materials and also implicit costs such as opportunity cost.
7. Opportunity cost is the value of the next best alternative. 
8. For example, if a business owner's next best alternative was to accept a job with a £30,000 salary, that would be the opportunity cost of running the business.
9. For example, if explicit costs such as raw materials cost £20,000 and the opportunity cost of the business is £30,000 then the business should make a revenue of at least £50,000 for the business owner to be motivated to continue in the long run.

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