AP Micro Test 3

Fixed Input

An input whose quantity is fixed for a period of time and cannot be varied

Variable Input

An input whose quantity the firm can vary at any time

Long Run

The time period in which all inputs or prices (including nominal wages) are fully flexible or can be varied

Short Run

The time period in which many production costs, including nominal wages, are not fully flexible; time period in which at least one input is fixed.

Total Product Curve

Shows how the quantity of output depends on the quantity of the variable input, for a given quantity of the fixed input

Marginal Product

The additional quantity of output produced by using one more unit of an input

Calculate Marginal Product

ΔQ / ΔL

Slope of Total Product Curve

Slope = Marginal Product

Diminishing Returns To Inputs

When an increase in the quantity of that input, holding the levels of all other inputs fixed, leads to a decline in the marginal product of that input.

Position of Total Product Curve given Different Input Levels

If you change the quantities of the other inputs, both the total product curve and the marginal product curve of the remaining input will shift

Fixed Cost (Overhead Cost)

A cost that does not depend on the quantity of output produced

Variable Cost

A cost that varies based on the quantity of output produced

Total Cost

Sum of fixed cost and variable cost

Total Cost Curve

Shows how total cost depends on the quantity of output

Marginal Cost

The cost of producing one more unit of output

Slope of Total Cost Curve

Marginal cost is equal to slope of total cost curve

Marginal Cost Curve

Shows how the cost of producing one more unit depends on the quantity that has already been produced

Average Total Cost

Total cost divided by quantity of output produced

Average Total Cost Curve Shape

U-Shaped

Average Fixed Cost

The fixed cost per unit of output

Average Variable Cost

The variable cost per unit of output

Spreading Effect

The larger the output, the greater the quantity of output over which the fixed cost is spread, leading to a lower average fixed cost

Diminishing Returns Effect

The larger the output, the lower the marginal product of the variable input, and the greater the additional amount of the variable input required to produce another unit of output, leading to a higher average variable cost

Minimum-Cost Output

The quantity of output at which average total cost is lowest

Min ATC = MC

Average total cost is equal to the marginal cost

Min ATC > MC

At any output greater than minimum-cost output, the marginal cost is greater than the average total cost and the average total cost is rising

Min ATC < MC

At any output less than minimum-cost output, the marginal cost is less than the average total cost and the average total cost is falling

MC and MPL (marginal product) Relationship

MC rises, MPL falls

MC falls, MPL rises

AVC and APL (Average Product) relationship

AVC rises, APL falls

AVC falls, APL rises

Long-Run Average Total Cost Curve

Shows the relationship between output and average total cost when fixed cost has been chosen to minimize average total cost for each level of output

Economies of Scale

When long-run average total cost declines as output increases

Increasing Returns to Scale

When output increases more than in proportion to an increase in all inputs

Can result from economies of scale

Minimum Efficient Scale

The smallest quantity at which a firm’s long-run average total costs is minimized

Diseconomies of Scale

When long-run average total cost increases as output increases

Decreasing Returns of Scale

When output increases less than in proportion to an increase in all inputs

Can result from diseconomies of scale

Constant Returns to Scale

When output increases directly in proportion to an increase in all inputs

Profit

Total Revenue - Total Cost

Explicit Cost

A cost that involves actually paying out money

Implicit Cost

Measured by the value, in dollar terms, of benefits that are foregone

Accounting Profit

A business’s total revenue minus the explicit cost and depreciation

Economic Profit

Total Revenue - Explicit Costs - Implicit Costs

Normal Profit

An economic profit equal to zero, just high enough to keep a firm engaged in its current activity

Principle of Marginal Analysis

Says that every activity should continue until marginal benefit equals marginal cost

Marginal Revenue

The change in total revenue generated by an additional unit of output

P > Min ATC

Firm profitable. Additional firms enter the industry in the long run

P = Min ATC

Firm breaks even. No incentive for any firm to enter or exit the industry in the long run

P < Min ATC

Firm unprofitable. The firm and other firms in the industry exit in the long run

P > Min AVC

Firm produces in the short run.

If 𝑃 < minimum 𝐴𝑇𝐶, firm covers variable cost and some but not all of fixed cost.

If 𝑃 > minimum 𝐴𝑇𝐶, firm covers all variable cost and fixed cost

P = Min AVC

Firm indifferent between producing in the short run or not. Firm exactly covers variable cost

P < Min AVC

Firm shuts down in the short run. Does not cover variable cost

Shut-Down Price

The market price at which a firm ceases production in the short run

Price-Taking Firm

A firm whose actions have no effect on the market price of the good or service it sells

Price-Taking Consumer

A consumer whose actions have no effect on the market price of the good or service purchased

Perfectly Competitive Market

All market participants, both consumers and producers, are price-takers

Perfectly Competitive Industry

An industry in which firms are price-takers

Conditions for Perfect Competition

Many buyers and sellers

Standardized Product

Free Entry & Exit

Full Information

Many Buyers and Sellers

For a market to be perfectly competitive, it must contain many firms, none of which have a large market share

Standardized Product

Describes a good produced by different firms, but that consumers regard as the same good; also known as a commodity

Free Entry & Exit

When new firms can easily enter into an industry and existing firms can easily leave that industry

Full Information

In a perfectly competitive market, consumers and firms have all the relevant information about the products and prices available

Industry Supply Curve

Shows the relationship between the price of a good and the total output of the industry as a whole

Short-Run Industry Supply Curve

Shows how the quantity supplied by an industry depends on the market price, given a fixed number of firms

Allocative Efficiency

Achieved when the goods and services produced are those most valued by society

Productive Efficiency

Achieved when firms minimize the average cost of producing their goods