AP® Microeconomics · Unit 3 · Topic 3.6
The Break-Even Point and Long-Run Entry and Exit
The break-even price equals minimum average total cost and the shutdown price equals minimum average variable cost; price relative to these two marks decides whether firms enter, stay, or exit, pushing economic profit toward zero.
A firm's marginal cost curve is its supply curve above minimum AVC, but two prices on that curve matter more than the rest. The break-even price sits at minimum ATC: at that price the firm earns zero economic profit, covering every cost including the normal return owners could get elsewhere. The shutdown price sits at minimum AVC: below it, the firm loses more by operating than by closing, since it can't even cover variable costs. Between those two prices, a firm stays open but loses money, because it's covering its variable costs plus part of its fixed costs, which beats shutting down and losing all of the fixed cost. Above break-even, it earns positive economic profit. Below shutdown, it exits.
Positive economic profit is a signal. Other firms see it and have no reason to stay out, since perfect competition assumes free entry and identical technology. Each new entrant adds its own supply curve to the market, shifting market supply right and pushing price down along every firm's demand curve, which is horizontal at the market price. As price falls toward minimum ATC, economic profit shrinks toward zero. Entry stops exactly when profit hits zero, because there's no more incentive to join.
This is the mirror image of exit: when price sits below minimum ATC, firms lose money, and those losses push the weakest firms out, shifting supply left and price back up. Both processes converge on the same long-run equilibrium, where price equals minimum ATC, economic profit is zero, and the industry has no further push to expand or contract. That zero-profit condition is the capstone of the perfect competition model.
Key terms
- Break-even price
- The price equal to minimum average total cost, where economic profit is exactly zero.
- Shutdown price
- The price equal to minimum average variable cost, below which a firm minimizes losses by closing.
- Economic profit
- Total revenue minus all costs, including the normal return owners forgo by not using resources elsewhere.
- Entry
- New firms joining an industry in response to positive economic profit, which shifts market supply right.
- Long-run equilibrium
- The state where price equals minimum ATC and economic profit is zero, so entry and exit stop.
Watch it explained
- How it worksHow do the break-even price and the shutdown price split supply into three zones?
- How it worksWalk me through entry pushing market supply right until economic profit hits zero.
- Worked exampleFind the break-even and shutdown prices when minimum ATC is 12 and minimum AVC is 7.
- Going furtherWhat happens to the market price when firms start exiting an industry making losses?
Check yourself
End of topic.