Question

What are the short run and long run criteria for shutting down a business?

Answer 1

Short-run shutdown compared to long-run exit[edit]
A decision to shut down means that the firm is temporarily suspending production. It does not mean that the firm is going out of business (exiting the industry). If market conditions improve, due to prices increasing or production costs falling, the firm can resume production. Shutting down is a short-run decision. A firm that has shut down is not producing, but it still retains its capital assets; however, the firm cannot leave the industry or avoid its fixed costs in the short run.

However, a firm will not choose to incur losses indefinitely. In the long run, the firm will have to decide whether to continue in business or to leave the industry and pursue profits elsewhere. Exit is a long-term decision. A firm that has exited an industry has avoided all commitments and freed all capital for use in more profitable enterprises. A firm that exits an industry earns no revenue but it incurs no costs, fixed or variable.

The long-run decision is based on the relationship of the price P and long-run average costs LRAC. If P ≥ LRAC then the firm will not exit the industry. If P < LRAC, then the firm will exit the industry. These comparisons will be made after the firm has made the necessary and feasible long-term adjustments

In the long run, a firm operates where marginal revenue equals long-run marginal costs, but only if it decides to remain in the industry. Thus, the firm's long-run supply curve is the long run marginal cost curve above the minimum point of the long run average cost curve.