9781118041581

258 Chapter 6 Cost Analysis

[6.5]

The first term, R VC, is referred to as the product’s contribution.As long as

revenue exceeds variable costs (or, equivalently, P AVC), the product is mak-

ing a positive contribution to the firm’s fixed costs. Observe that price exceeds

average variable cost in Figure 6.7. (The average variable cost curve is U-

shaped, and it lies below the AC curve because it excludes all fixed costs.)

Therefore, continuing to produce the good makes a contribution to fixed costs.

(In fact, output Q* delivers maximum contribution because MR MC.) If

instead the firm were to discontinue production (Q 0), this contribution

would be lost. In the short run, the firm is stuck with its fixed costs. It will incur

these costs whether or not it produces output. If the firm shuts down, its profit

will be 

FC. (The firm will earn no revenues but will pay its fixed costs.)

(RVC)FC(PAVC)QFC.

FIGURE 6.7

Shutting Down

In the short run, the

firm should continue

to produce at Q* (even

if it is suffering a loss)

so long as price

exceeds average

variable cost. In the

long run, the firm

should shut down if

price falls short of

average cost.

P*

Q*

Output

Dollars per Unit of Output

Marginal

revenue

Demand

MC

AC

AVC

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