AP Micro Unit 3

i hate this class.

Economies of Scale

An advantage created when a firm makes more money by producing more

Long Run

All factors of production are variable

• may adjust scale of operations

• may enter or exit a market

Long Run Equilibrium

When an economy reaches equilibrium and no firms have incentive to enter or exit

• perfect competition → Firms earn 0 profit

• MR = MC

• Price = Minimum ATC

• No economic profits

  • Normal profit

• Productive Efficiency → P = min(ATC)

• Allocative Efficiency → P = MC

Scale of Production (Long run concept)

Quantity of output 

Increasing Returns to Scale

output increasing by more than the proportional change in all inputs

Decreasing Returns to Scale

change in inputs is less than proportionate to increase in outputs

Increasing Marginal Returns

Total output increases, as does marginal product

• specialization

Diminishing marginal returns

Firms reach a point where adding inputs will lead to diminishing increases in output

Negative Marginal returns

Inputs are too high and they conflict

• Marginal product will be negative

• Total product will be decreasing 

Variable Cost

Easily changed factors

Short Run

Where at least one factor of production is fixed

• business cannot adjust all the resources to fit in the market

• may not respond to change well

• law of diminishing returns 

  • more inputs (labor) leads to less outputs eventually

Fixed cost

Not easily changed factors

Shutdown of Production

Total revenue is less than variable costs of production → shutdown production

ATC

ATC = Total Cost / Quantity 

AVC

Variable Cost / Quantity

AFC

Fixed Cost / Quantity

TR 

TR = Price x Q

MR

Marginal Revenue = ΔTotal Revenue / ΔQuantity

Profit

Profit = Total revenue - Total Costs

Explicit Costs

Something you pay for outright

• loans

• lease

• rent

• wages

• advertising

Implicit Costs

Opportunity costs 

• Time 

• depreciation of equipment 

• owners salary 

Accounting Profit

Total Revenue - EXPLICIT COSTS

Economic Profit

Total Revenue - (EXPLICIT + IMPLICIT COSTS)

Total Cost

TC = Fixed Cost + Variable Cost

Marginal Cost

MC = ΔTC / ΔQ

Marginal Price

MP  = ΔTP / ΔQ

Average Revenue

AR = Total Revenue / Quantity (=P in perfect competition)

Average Cost

AC = Total Cost / Quantity

Average Price

AP = Total Price / Quantity

Where does Marginal Cost intersect Average Total Cost?

At the ATC minimum point

Profit Maximization

Marginal Revenue will equal Marginal Cost

• If MC is rising

Perfect Competition

• Price takers not setters

• same exact product

• buyers have all the information

• Market Price

• No barriers to entry or exit 

Price characteristics of a perfect comp

MR = MC

• P = MR = AR = DC

Short Run firms produce if

Price ≥ AVC

firms shut down if 

Price < AVC

Profit happens when

Price > ATC

Loss but still produce

ATC > Price ≥ AVC

Firms enter if

Total revenue > total cost (+ Profit)

Firms exit if

Total revenue < Total Cost

Average fixed costs decline when…

Quantity increases

MC intersects at ( . . . ) and ( . . . ) at their minimums

ATC and AVC

AVC approaches ( . . ) as (. . . ) Q increases (AFC Shrinks)

ATC as Quantity

Minimum Efficient Scale

• The lowest quantity at which a firm minimizes long-run average total cost.

• Shows economies of scale → constant returns → diseconomies

Long run supply curve is…

Horizontal

• entry of new firms does not shift input prices

• prices are the way they are 

LONG RUN SUPPLY IS PERFECTLY ELASTIC 

Perfect competition firm graph includes

• horizontal demabd

  • MR = AR = P

• Upward sloping MC

• U shaped ATC

Production Function Graph

Think: 

• Marginal returns

  • Increasing = TP curve gets steeper

  • Diminishing = TP rises but curve will flatten

  • Negative = TP goes down

• When TP is steep → MP is high 

• When TP flattens → MP falls

• When TP goes down → MP is negative

• Average product

  • rises → MP > AP

  • falls MP < AP

Marginal cost, average cost and variable cost

MC Curve

• rises sharp

• intersects at other minimum points

AVC curve 

• Always below ATC

• decreases but will increase due to diminishing marginal returns

ATC Curve 

• Always above AVC

• gaps between AVC and ATC as Q increases

Firm produces at MC = MR