Shutdown Points | A-Level Economics Notes

These revision notes cover everything you need to know about Shutdown Points for A-Level Economics. They're designed for students studying AQA A-Level Economics, Edexcel A-Level Economics, and Edexcel International A-Level Economics. Written by Jaisul Naik, UCL Economics graduate and A-Level Economics tutor since 2017.

What is profit?

Profit is the difference between total revenue and total costs.

Profit is an entrepreneur's reward for taking a risk.

For example:

• total revenue = £200,000
• total costs = £90,000
• profit = £110,000

What is economic profit?

Economic profit factors in opportunity cost.

Economic profit is the difference between total revenue and total costs, including opportunity cost.

For example, imagine a driving instructor:

• average revenue = £40 per hour
• average cost = £10 per hour
• opportunity cost from working 1 hour in another job/business = £20 per hour
• economic profit = £10

This business owner is making £30 of profit per unit.

Out of this, they are making £10 of economic profit per unit.

What is normal profit?

Normal profit is made when a business owner makes zero economic profit.

Normal profit is made when average revenue = average costs, including opportunity cost.

For example, imagine a driving instructor:

• average revenue = £40 per hour
• average cost = £10 per hour
• opportunity cost from working 1 hour in another job/business = £30 per hour
• economic profit = £0

In this example, the business owner is making £30 profit per hour.

This is not necessarily attractive or unattractive, as it is equal to what the driving instructor would be earning in their next best alternative, whether that is a job or a business.

What is supernormal profit?

Supernormal profit is made when total revenue exceeds total costs, including opportunity cost.

For example, imagine a driving instructor:

• average revenue = £80 per hour
• average cost = £10 per hour
• opportunity cost from working 1 hour in another job/business = £30 per hour
• economic profit = £40 per hour

What is the short-run?

In the short-run, there is at least one fixed factor of production.

For example, in the short-run, land might be fixed.

What is the shutdown condition in the short-run?

The short-run shutdown condition is AR = AVC (average revenue = average variable cost).

A shutdown in the short-run means that a firm will temporarily stop producing output.

We can assume that fixed costs e.g. rent is a sunk cost, meaning they are not recoverable even if a firm leaves the market.

Therefore, the business owner will only shut down if they are unable to cover their variable costs e.g. fuel.

For example, this driving instructor will not shutdown.

• average revenue = £40 per hour
• average fixed cost = £100 per hour (this is the cost to pay off the vehicle/office)
• average variable cost = £10 per hour (this is the cost of fuel etc.)

Despite high fixed costs, the firm is able to cover its variable costs. It will be able to pay off its fixed costs as time goes on and then make a profit in the long-run.

For example, this driving instructor will shutdown.

• average revenue = £40 per hour
• average fixed cost = £10 per hour (this is the cost to pay off the vehicle/office)
• average variable cost = £41 per hour (this is the cost of fuel etc.)

This firm cannot cover their variable costs.

What is the shutdown point in the long-run?

1. In the long-run, firms choose to shutdown if average revenue is less than average cost
2. This means that firms are not able to make normal profits.
3. The firm's average revenue is unable to cover its average costs including opportunity cost.
4. The business owner would be better off in their next best alternative e.g. a job/ another business.

For example, this driving instructor will not shutdown.

• average revenue = £40 per hour
• average cost = £10 per hour
• opportunity cost = £25 per hour

For example, this driving instructor will shutdown.

• average revenue = £40 per hour
• average cost = £10 per hour
• opportunity cost = £35 per hour

Summary questions

1. What is profit?
2. What is economic profit?
3. What is normal profit?
4. What is supernormal profit?
5. What is the short-run shutdown condition?
6. What is the long-run shutdown condition?

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