The “Shut-down Rule” – When should a firm shut down to minimize its losses?

A firm in a competitive market may find itself experiencing economic losses if demand for its product falls or if the supply from other firms increases too rapidly. No one likes losing money, but should a firm get out of the market as soon as losses are experienced? Not necessarily.

If the losses a firm experiences are relatively small, it may be better off sticking things out and hoping price rises, returning the firm to a break-even level. However, if losses are greater than the firm’s fixed costs, the firm can actually minimize its losses by shutting down.

This lesson illustrates two situations in which a firm in a perfectly competitive market is earning economic losses. In one case, the losses are less than the firm’s total fixed costs. In another, the firm’s losses exceed its fixed costs, meaning the firm is better off shutting down.

To order practice activities on this and other lessons from the Econ Classroom, click here.

For student revision guides and teacher PowerPoints, click here.

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