A shutdown point is a state of operations where an organization encounters no advantage for proceeding with operations or from closing down briefly; it is the mix of yield and cost where the organization gains simply enough income to take care of its aggregate variable expenses. In the terms of economics, we can describe it in two terms: Short run shutdown and Long run shutdown. Let us take an instance related to the firm.

Example:

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An XYZ cooking class takes a cooking session for the people interested in making different kinds of cuisine. The firm has to pay the rent of their space say \$15,000/ month. Now, if the firm decides to continue its marginal cost for hiring helpers is \$20,000/ month, and if the firm decides to shut down, it still has to pay the rent of that space, but they would no more need to hire labors and neither they need to pay for ingredients.

Here, we can consider different situations:

Situation 1:

Let’s say the cooking classes does not have any student and it does not make any income, it losses \$15,000 which is the fixed cost (rent). So here the firm does not have any income, so hiring helpers and buying ingredients will increase virtual cost and losses too. Therefore, it should shut down and expose the fixed cost.

If we calculate it, price = total cost – (fixed cost + virtual cost)

= 0- (15,000) = -\$15,000

Situation 2:

Assuming it has the students to learn cooking that gives the income of \$15,000/ month, but eventually it undergoes loss of \$20,000 due to having helpers and bringing ingredients to cook. So here the firm losses are greater due to not making enough revenue to offset the increased virtual cost and fixed cost too. So in this case the firm should shut down immediately.

If we calculate it, price = total cost – (fixed cost + virtual cost)

= 15,000 – (15,000+20,000) = – \$20,000

Situation 3:

If the cooking classes earns the income of \$35,000/ month but experience loss of \$5000, then the income earned by firm is high enough that the losses diminish when it remains open, so the firm should remain open and continue the classes.

If we calculate it, price = total cost – (fixed cost + virtual cost)

= 35,000- (15,000 + 20,000) = – \$5000

In all the 3 circumstances the firm misfortunes cash. At the point when the rental contract expires in long run, accepting incomes won’t enhance the firm should close down the business. In short run, however, the choice fluctuates relies on the level of misfortune and whether the firm can take care of virtual expense or not.

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