AP Microeconomics: Unit 3: Production, Cost, and the Perfect Competition Model

Variable Cost (VC)

A cost that changes as output changes

Fixed Cost (FC)

A cost that must be paid even when a firm's output is zero; a cost that is the same at all output levels

Short Run

A period during which at least one of a firm's resources is fixed

Why do ATC and AVC get closer together?

AFC is always decreasing

Firm

An individual or group of individuals who work together to produce goods and services for profit

Barriers to Entry

Business practices or conditions that make it difficult for new firms to enter the market

What causes cost curves to shift?

Changes to input costs or productivity

Normal Profit

Economic profit is 0

Total Cost

Fixed Costs + Variable Costs

Shut-Down Rule (Short Run)

If TR < VC, the firm should shut down

Implicit Costs

Indirect, non-purchased, or opportunity costs of resources provided by the entrepreneur

Economies of Scale

Long-run ATC decreases as output increases

Diseconomies of Scale

Long-run ATC increases as output increases

Constant Returns to Scale (Efficient Scale)

Long-run ATC is constant as output increases

Relationship between MC and ATC and AVC

MC crosses through the minimums of ATC and AVC. If MC is below ATC, then ATC is falling. If MC is below AVC, then AVC is falling. If MC is above ATC, then ATC is rising. If MC is above AVC, then AVC is rising.

Relationship between MC and MP

MC decreases initially (specialization). MC eventually rises (diminishing returns).

Relationship between MP and AP

MP crosses through the maximum of AP. When MP is above AP, AP is rising. When MP is below AP, AP is falling.

Profit-Maximization Rule

MR = MC

Why does MP decrease?

More and more of the variable inputs are being added to a fixed amount of the fixed inputs

Perfect Competition

Price taking firms, lots of competitors, identical products, free entry and exit in the long run, zero economic profit in the long run

Total Revenue

Price x Quantity

If MR < MC, the firm should

Produce less output

If MR > MC, the firm should

Produce more output

Fixed Inputs

Production inputs that cannot be changed in the short run

Variable Inputs

Production inputs that the firm can adjust in the short run to meet changes in demand for their output

Why does MP increase initially?

Specialization and division of labor

Explicit Costs

The actual payments a firm makes to its factors of production and other suppliers

Marginal Cost (MC)

The additional cost of producing one more unit of output, MC = Change in TC / Change in Q

Marginal Product (MP)

The additional output produced by one more unit of a variable input, MP = Change in TP / Change in Input

Profit

The amount of money a firm gets to keep after it has paid for all of its costs or expenses

Average Fixed Cost (AFC)

The average per-unit fixed cost of production for a given quantity of output, AFC = FC / Q

Average Total Cost (ATC)

The average per-unit total cost of production for a given quantity of output, ATC = TC / Q, ATC = AFC + AVC

Average Variable Cost (AVC)

The average per-unit variable cost of production for a given quantity of output, AVC = VC / Q

Average Product (AP)

The average quantity of output produced by one unit of a variable input, AP = TP / Input

Marginal Revenue (MR)

The change in total revenue resulting from the sale of an additional unit of a product, MR = Change in TR / Change in Quantity

Minimum Efficient Scale

The lowest rate of output at which a firm takes full advantage of economies of scale

Production Function

The relationship between the quantity of inputs a firm uses and the quantity of output it produces

Plant Capacity

The size of the factory building, the amount of machinery and equipment, and other capital resources

Total Cost (TC)

The sum of fixed and variable costs

Long Run

The time period in which all inputs can be varied

Total Product (TP)

The total quantity of output produced by a certain amount of inputs

Accounting Profit

Total Revenue - Explicit Costs

Economic Profit

Total Revenue - Total Cost (Explicit and Implicit)

Relationship between MP and TP

When MP is increasing, TP is increasing at an increasing rate. When MP is positive but decreasing, TP is increasing at decreasing rate. When MP is negative, TP is decreasing. TP is greatest when MP = 0.