AP Microecon 3.1-3.4 Study Guide

What is the production function?

the relationship between quantity of inputs used to make a good and the quantity of output of that good

total product

total output produced by a firm

Average Product

total product/units of variable input (aka labor)

Marginal Product

the increase in output that arises from an additional unit of input

What is the relationship between Total Product and Marginal Product

Marginal product is the slope of the total product (also known as the derivative)

What is the relationship between Average Product and Marginal Product

When MP is above AP it pulls AP up. When MP is below AP it pulls AP down. It is like AP is your GPA and MP is the grade you get in one class

When MP is increasing, what is TP doing

Increasing at an increasing rate

When MP is decreasing, what is TP doing

Increasing at a decreasing rate

When MP is negative, what is TP doing

TP is decreasing

Where is TP maximized

When MP = 0

Why does MP go up at the beginning?

Specialization causes additional inputs to increase production

Why does MP then start to decrease

Diminishing Marginal Returns

What is Diminishing Marginal Returns

As you add more variable inputs to fixed input, the production you get from additional inputs will be less and less. Imagine the paper chain, and by adding more workers, without adding additional staplers, then the additional workers will not add much to the paper chain.

What is the relationship between Marginal Product and Marginal Cost

They are the inverse (or mirror) of each other. When MP is increasing, MC is decreasing and vice versa

fixed input

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

What is a variable input

an input whose quantity the firm can vary at any time

what is the difference between the short run and long run?

In the short run at least one input is fixed. In the long run all inputs are variable

What is meant by plant capacity

A firm's maximum level of production in the short run

Where is Average Product Maximized?

Where Marginal Product = Average Product

What is fixed cost

A cost that must be paid when a firm's output is zero. A cost that is the same at all output levels (e.g. rent)

What is variable cost

a cost that varies with the level of output. As you add more materials and workers to produce more product your variable cost will increase

What is Total Cost

fixed cost + variable cost

What is Marginal Cost

the cost of producing one more unit of a good

What is the shape of the Marginal Cost curve?

Nike Swoosh - it initially goes down due to specialization, but then starts to rise due to diminishing marginal product

What is Average Fixed Cost?

fixed cost divided by the quantity of output

What is the shape of the Average Fixed Cost curve?

always decreasing - it should be approaching the x-axis as output increases

What is Average Variable Cost

variable cost divided by the quantity of output

What is the shape of the Average Variable Cost curve?

U-Shaped

What is Average Total Cost?

total cost divided by the quantity of output

What is the shape of the Average Total Cost curve?

U-shaped

What is the gap between the ATC and AVC curves? Why does it shrink over time?

The gap between ATC and AVC is average fixed cost, and as AFC is consistently getting smaller, the gap between ATC and AVC shrinks with more output

Why is the ATC curve shaped the way it is?

It first goes down as AFC is decreasing, but then increases due to diminishing marginal product

What is the relationship between MC and AVC

When MC is below AVC it is pulling AVC down, and when MC is above AVC it is pulling AVC up.

Where does MC cross AVC

At the AVC curve's minimum

What is the relationship between MC and ATC

When MC is below ATC it is pulling ATC down, and when MC is above ATC it is pulling ATC up.

Where does MC cross ATC?

at the ATC curve's minimum

What is the difference between long run and short run for the cost curves?

All costs are variable in the long-run. No long-run fixed costs

What is the shape of the long-run ATC curve?

U-Shaped

What is the downward portion of the long-run ATC curve?

Economies of Scale

What is Economies of Scale?

when the average cost of producing a good or service falls as the quantity produced increases

What causes Economies of Scale?

Specialization and taking advantage of bigness. If you have all the capital in place to produce a product at a low marginal cost, running all those machines to produce more and more product will bring down your average total cost

What is constant returns to scale?

the property whereby long-run average total cost stays the same as the quantity of output changes

Where is constant returns to scale found on the long-run ATC curve?

The flat portion at the bottom of the curve

What is the upward sloping portion of the long-run ATC curve?

Diseconomies of Scale

What is Diseconomies of Scale

the property whereby long-run average total cost rises as the quantity of output increases

What causes Diseconomies of Scale?

• Larger businesses difficult to coordinate

• As a business gets larger, communication becomes more difficult

• Workers might feel less a part of the business

What is increasing returns to scale?

When output increases at a greater rate than inputs (aka Economies of Scale) If you double inputs but more than double outputs

What is decreasing returns to scale?

When output increases at a smaller rate than adding inputs (aka Diseconomies of Scale) If you double inputs but outputs increase do not double

Where is Minimum Efficient Scale found

At the bottom of the long-run ATC curve. It is when Economies of Scale stops and constant returns to scale sets in.

Where should a firm produce in the long-run?

At a place where long-run ATC is minimized

What causes cost curves to move up?

An increase in costs - taxes, labor costs, materiel costs, etc.

What causes cost curves to move down?

A decrease in costs - lower taxes, lower labor costs, lower material costs, etc.

explicit cost

Money spent on inputs for a business - labor, capital, natural resources, etc.

What is implicit cost?

the monetary value of an opportunity cost (e.g. I could earn $30,000 being an tutor, but have instead decided to be an Uber driver)

Accounting Profit

total revenue minus total explicit cost

Economic Profit

total revenue minus total cost, including both explicit and implicit costs

Normal Profit

Covers the explicit costs and forgone income (zero economic profit)

Production Function Graph

Short Run Production Function Graph

Long Run Average Total Cost Curve