Final answer:
The break-even point occurs when a company's contribution margin covers all fixed costs, resulting in no profit or loss. If the price is below the AVC, the firm should shut down to minimize losses.
Step-by-step explanation:
When a company sells enough units for the contribution margin to just cover fixed costs, it has reached what is known as the break-even point. This is the point where no profit is made, but all costs associated with producing and selling the product have been recouped. If a firm is facing a price that falls below its Average Variable Cost (AVC), it will not be able to earn sufficient revenue to cover its variable costs, and would be better off shutting down production to minimize losses. This is because, at this point, the firm would lose all its fixed costs plus some variable costs if it continues operating. The shutdown point is defined as the intersection of the AVC curve and the Marginal Cost (MC) curve, indicating the price below which the firm should cease production to avoid larger losses.
However, if the market price is above the shutdown point (price > minimum AVC), the company covers its variable costs and at least a portion of its fixed costs, even if it operates at a loss. It should stay in operation in such a scenario because the losses will be smaller compared to a complete shutdown where the company would have to incur the full amount of its fixed costs. The key principle for decision-making is if MR = MC, meaning that the revenue from selling one more unit equals the cost of producing that unit, then the firm should continue producing output.