Final answer:
The break-even point can be determined by comparing total revenue with total cost, where profit is zero; using the average cost curve to identify the point of no economic profits; and understanding the shutdown point below which the firm cannot cover its variable costs and should cease production in the short run.
Step-by-step explanation:
To understand how firms decide whether they are making sufficient profits to stay in business or whether they should shut down, we can use three methods to determine the break-even point.
Calculate profits by comparing total revenue and total cost. When the total revenue equals the total cost, the firm is at the break-even point and earns zero profits.
Identify profits and losses with the average cost curve. The break-even point is where the market price intersects the minimum of the average cost curve, indicating no economic profits.
Explain the shutdown point. This is defined as the price or point where the firm's total revenue is equal to its total variable costs. If the market price falls below this point, the firm should shut down immediately in the short run.
Additionally, a firm needs to determine the price at which it should continue producing in the short run. If the market price covers the average variable costs but is below the average total costs, the firm can operate at a loss in the short run, as long as it covers the variable costs. However, it cannot sustain this in the long run without incurring losses.