AP Econ Unit 3 Unit Test Review
Ryan quit a job with a daily salary and opened a business. On a daily basis, the total revenue of the business is $200, and the explicit costs of the business are $120. If Ryan has zero economic profits, what must be the value of Ryan's implicit costs?
$80 (Total revenue minus explicit costs equals accounting profits. Subtracting opportunity cost from accounting profits yields economic profits. In this example, accounting profits are $200−$120=$80. If economic profits are zero, the implicit cost (the individual's forgone wages) must be $80. That is, the individual's economic profit is $80−$80=$0.)
Three Rules
1. A firm should produce the output level at which (MR=MC) 2. A firm should charge the price on the demand curve for its optimal output level (P=Demand) 3. A firm should shut down and produce zero output if TR is less than total variable cost (TVC) (TR<TVC {Shutdown})
Which of the following statements regarding accounting profits, opportunity costs, and economic profits is true?
If accounting profits are less than opportunity costs, there will be economic losses. (Total revenue minus explicit costs equals accounting profits. Subtracting opportunity costs from accounting profits yields economic profits. Therefore, if accounting profits are less than opportunity costs, there will be economic losses.)
Total Profit
The difference between the firms total revenue and total cost at a given level of output T(pi) = TR -TC T(Pi) = Q x A(pi)
Assume a competitive firm is producing where price (P) and marginal revenue (MR) are greater than marginal cost (MC) and average variable cost (AVC). Which of the following is true regarding the firm's short-run output level?
The firm is producing too little and should increase its output level until P = MR = MC (The competitive firm should continue to produce up to the output level where price, which is equal to marginal revenue (MR) for a competitive firm, equals marginal cost (MC). If P and MR exceed MC, then there are units of output that the firm is not producing that would be profitable.)
Total Revenue (TR)
The total income the firm receives from selling a given level of output (Q) at a particular price (P) TR = PxQ
Price Takers
To have no control over price and will charge the market-determined price for its product.
Based on the short-run production function graph above showing the relationship between the quantity of labor and total product, which of the following statements is true?
Total product is maximized when marginal product is zero. (With this short-run production function, the marginal product of labor initially rises, then begins to fall. At L0 the marginal product of labor is zero and total product is at its maximum because the change in total product is zero. When the change in total product is zero, adding an additional unit of the variable input results in a decline in total product.)
Total Profit
Total revenue - total cost
Which of the following provides an example of the law of diminishing returns?
As more of a variable input—for example, labor is used with a fixed number of machines— output increases but at a diminishing rate. (The law of diminishing returns states that as more of a variable input is added to a fixed input, output eventually increases at a decreasing rate. This is a short-run concept using one variable input and at least one fixed input.)
Average profit
Average revenue - average total cost
At its current level of output, a firm's total revenue is greater than its total variable cost but less than its total cost. If the firm is producing at the point where marginal revenue is equal to marginal cost, what should the firm do to maximize profit in the short run?
Continue to produce at its current level of output to minimize losses. (The firm will minimize its losses by continuing to operate in the short run. Its total revenue is greater than its total variable cost. Because it earns more than enough to cover its total variable costs, the excess amount over the total variable cost covers part of its fixed cost. Thus the firm minimizes its losses by continuing to operate rather shutting down.)
Max Profit
MR = MC (A perfectly competitive firm will maximize its total profit by producing the output level at which marginal revenue equals marginal cost.
When a competitive firm maximizes short-run economic profits, it produces at the output level where...
Marginal revenue equals marginal cost. (Profit maximization occurs where marginal revenue (price) equals marginal cost.)
Assume Nadia voluntarily leaves a job with a salary of $100 per day to open and run a restaurant instead. After deducting all explicit costs from the restaurant revenues, Nadia has a gain of $120. Assuming there are no additional implicit costs, which of the following statements is true?
Nadia has an economic profit of $20. (Total revenue minus explicit costs equals accounting profits. Deducting any opportunity costs from accounting profits yields economic profits. Rational decision making should include all costs, and, thus, be based on economic profit or loss. In this example, accounting profit is stated as $120. Subtracting the opportunity cost of forgone wages ($100)yields an economic profit of $20. Economic profit is positive since accounting profit exceeds the opportunity cost of lost wages.)
In the absence of barriers to entry, a typical firm is currently in long-run equilibrium. Assume there is an increase in the market demand for the good that the firm is producing. Which of the following will happen in the long run?
New Firms will enter the market (The increase in market demand shifts the market demand curve to the right, resulting in an increase in the price. As a result, all existing firms will increase output to where marginal cost equals marginal revenue and earn positive economic profit in the short run. In the long-run, incentivized by the short-run profits, new firms will enter the market, driving economic profits down to zero.)
Important
Productivity and cost graphs look the same for any firm, regardless of whether the firm sells its output in a perfectly competitive, monopolistic competitive, or oligopolistic product market.
Marginal Profit
The change in total profit resulting from the firm selling one more unit of output M(pi) = (Delta)T(pi)/(Delta)Q M(pi) = MR-MC
Marginal Revenue (MR)
The change in total revenue resulting from the firm selling one more unit of output MR = (Delta)TR/(Delta)Q
In the short run, which of the following must be true for a perfectly competitive firm that is maximizing profits?
The firm will produce where MR = MC as P is greater than average variable cost. (The profit-maximizing firm will produce where MR = MC. If price is greater than ATC, the firm has economic profits. The firm will still produce with economic losses as long as P is greater than average variable cost, as the losses will be less than fixed costs, which would be the losses if the firm shuts down.)
Assume the marginal product of labor first rises, reaches a maximum, and then falls. If the average product of labor is falling, which of the following is true?
The marginal product of labor must be falling. (The average product of labor will also rise, reach a maximum, and then decrease. If the average product of labor is decreasing, the marginal product of labor is falling and is below the average product of labor, reducing the average product of labor.)
Average Profit
The profit the firm receives from one unit at a given level of output (= per-unit profit) A(pi) = T(pi)/Q A(pi) = AR-ATC A(pi) = P-ATC
Average Revenue (AR)
The revenue the firm receives from one unit at a given level of output AR = TR/Q
Marginal profit
marginal revenue - marginal cost
The graph above shows the short-run cost and revenue curves for a perfectly competitive firm. Assume that the market price is P0 and the firm is producing at quantity Q2. To maximize profit, the firm should...
produce quantity Q1, where price is equal to marginal cost. (The profit-maximizing competitive firm should produce where P(or MR) =MC at Q1. The firm will have a loss, since P is less than ATC.)
