Unit 3: AP Micro Vocabulary

Production Function

the way a firm combines inputs to produce an

output

Variable Inputs

inputs that can be changed in the short run

Fixed Inputs

inputs that can’t be changed in the short run

Short Run

the period of time during which there are fixed inputs; too short for a firm to alter its plant capacity

Plant Capacity

a firm’s maximum level of (potential) production

Long Run

period of time long enough for all inputs to be variable / for a firm to alter its plant capacity

Fixed Resources

Resources that don’t change with the quantity produced

Variable Resources

Resources that DO change with the quantity produced

Total product (TP)

total quantity produced with a given amount of inputs

Marginal Product (MP)

additional output produced by one more unit of a variable input (usually labor)

What is formula for MP?

Change in TP / Change in Input

Average Product (AP)

average quantity of output produced per unit of a variable input (usually labor)

What is formula for AP?

TP / Inputs

TPP

Total Physical Product

MPP

Marginal Physical Product

APP

Average Physical Product

Marginal Product is _________ of Total Product

slope

If MP is positive, TP is _________

Increasing

If MP is negative, TP is _________

Decreasing

If MP is _______, TP is _______.

zero, maximized

When MP is increasing, TP is _______ at an _______ rate

increasing, increasing

When MP is positive but decreasing, TP is ______ at a _______ rate.

increasing, decreasing

When MP is negative, TP is _______.

decreasing

If Average Product is less than Marginal Product, AP is _______.

increasing

If Average Product is greater than Marginal Product, MP is _______.

decreasing

When MP is above AP, AP is _____.

rising

When MP is below AP, AP is ____.

falling

Stage 1

• Increasing Marginal Returns

• Each additional worker helps specialize; workers can focus on being efficient at more specific tasks.

In Stage 1,
MP is ____ and _____.

TP is ______ at an ______ rate.

• positive, increasing

• increasing, increasing

Stage 2

• Decreasing Marginal Returns

• We already have specialized labor; now each new worker is trying to work from the same set of scarce fixed resources, so they add less and less.

In Stage 2,
MP is ____ and _____.

TP is ______ at an ______ rate.

• positive, decreasing

• Increasing, decreasing

Law of Diminishing (Marginal) Returns

As variable inputs are added to a given number of fixed inputs, the additional output produced from each additional worker will eventually fall.

Stage 3

• Negative Marginal Returns

• At this point, we now have so many workers trying to work with the same fixed resources that they actively get in each other’s way.

  -“too many cooks in the kitchen”

In stage 3,

MP is _____

TP is ______

• negative

• decreasing

Recall that we will want to purchase additional units, or hire additional inputs, until…….

Marginal Benefit (MB) = Marginal Cost (MC)

Recall that we will want to purchase additional units, or hire additional inputs,, and stop before….

Marginal Benefit (MB) < Marginal Cost (MC)

MC

the cost of producing an additional unit of output

MC is _____, when MP is _____.

MC - increasing

MP - decreasing

MP and MC are _________

mirror images of each other

When does stage 1 end?

• ends when MP is at its maximum.

• TP hits an inflection point when MP is maximized.

• AP is below MP but increasing.

When does stage 2 end?

• ends when MP is zero

• TP is at its maximum when MP is zero.

• AP crosses MP and begins decreasing.

• AP is at its maximum at this intersection

What happens in stage 3?

• must stop hiring before this stage

• MP is negative. TP is decreasing.

• AP is above MP

Fixed Cost

a cost that must be paid even when a firm’s output is zero; does not change with the output level (ex: rent)

Variable Cost

a cost that changes as output changes (ex: labor)

Total Cost (TC)

Fixed Cost + Variable Cost

AFC =

FC / Q

AVC =

VC / Q

ATC = (divide)

TC / Q

ATC = (add)

AFC + AVC

Marginal Cost (MC)

the additional cost of producing one more unit of output

MC =

Change in TC / Change in Q

AFC is always _____; approaches (but never reaches) zero.

decreasing

when MC = AVC, AVC is at a ________.

minimum

when MC = ATC, ATC is at a _________.

minimum

When MC is below AVC, AVC _____;
when MC is above AVC, AVC _____;

decreases

increases

when MC is above ATC, ATC _____;

When MC is below ATC, ATC _____;

increases

decreases

ATC and AVC get closer and closer but ________

never touch

TC =

FC + VC

Draw Graph! MC, AVC, ATC, and AFC

Increasing Returns to Scale

output is increasing at a faster rate than inputs -

also called economies of scale - an extra 10% on inputs yields >10% in new

output

Constant Returns to Scale

output is increasing at the same rate as inputs - an

extra 10% on inputs yields 10% in new output

Decreasing Returns to Scale

output is increasing at a slower rate than input -

also called diseconomies of scale - an extra 10% on inputs yields <10% in new

output

Economies of Scale (w/ Long-Run Average Total Cost Curve - LRATC)

• LRATC decreases as output increases

• Long Run Average Cost falls because mass production techniques are used

Constant Returns to Scale (Efficient Scale)

• LRATC is constant as output increases

• The long-run average total cost is as low as it can get

Diseconomies of Scale

• LRATC increases as output increases

• Long run average costs increase as firm gets too big and difficult to manage

Minimum Efficient Scale

number of firms that would be ideal in a market

Why do economies of scale occur?

Firms that produce more can better use Mass Production Techniques and Specialization

Profit

• Firms are primarily incentivized to maximize it

• motive to do things like innovate, reduce costs, and be responsive to changes in consumer demand.

Explicit costs

refers to money tangibly

spent on materials, utilities, labor, rent,

capital, etc.

“Out of pocket expenses”

Implicit Cost

refers to the monetary value of

opportunity cost

“Forgone income”

Accounting Costs

Synonym for explicit costs

Economic Costs

refers to both explicit and implicit costs added together.

Accounting Profit =

Total Revenue - Explicit Costs

Total Revenue =

Price * Quantity

Explicit Costs =

Total Fixed Costs + Total Variable Costs

Economic Profit = (3 ways to calculate)

= Total Revenue - Explicit Costs - Implicit Costs

= Accounting Profit - Implicit Costs

= Total Revenue - Economic Costs

Economic Profit takes our Accounting Profit and additionally considers our

_________.

opportunity cost

Accountants only look at ______

explicit costs

Economists examine _____

explicit costs and implicit costs

economic profit of $0

• normal profit

• This means that they are indifferent between what they are currently doing and their next-best alternative.

economic profit > 0 (Accounting Profit > Opportunity Cost)

this business is preferable to the alternative use of the entrepreneur’s time

economic profit < 0 (Accounting Profit < Opportunity Cost)

the entrepreneur would be better off if they pursued their next-best alternative

Economic Profit tells us what?

whether a firm should stay in that industry, or if their time/resources would be better used elsewhere.

Economic Profit ≥ 0

the firm will stay in business.

Economic Profit < 0

the firm will consider other alternatives.

Firms earn a profit when ….

Total Revenue > Total Cost

They apply marginal analysis to attempt to

maximize profits (or minimize losses)

Firms will continue to produce as long as marginal revenue from an additional

unit is

greater than or equal to the marginal cost of that unit.

PROFIT MAXIMIZATION RULE:

MR = MC

Marginal Revenue is the

Price; MR = P

Marginal Cost is initially

decreasing, then increases.

If MR > MC,

the firm should produce more.

If MR < MC,

the firm should produce less.

MR =

ΔTotal Revenue / ΔQuantity

MC =

ΔTotal Cost / ΔQuantity

If TR > TC,

the firm earns an economic profit.

If TR = TC,

the firm breaks even and earns a normal profit.

If TR < TC,

the firm earns an economic loss.

Perfect competition is defined by (4 things)

• no barriers to entry

• no product differentiation

• many sellers

• firms are price takers

In the short run, firms have fixed costs, variable costs, and no _______

price control