Microeconomics AP Unit 3 Review

Total Revenue

The total amount of money a firm receives by selling goods or services

Explicit Cost

Payments paid by firms for using the resources of others (out of pocket costs ex: rent, wages, bills)

Implicit Cost

The opportunity cost that firms "pay" for using their own resources (forgone wages, time)

Accountants

Look at only explicit costs
Accountancy profit=Total Revenue-Accounting costs(explicit only)

Economists

Examine both explicit and implicit costs
Economic profit=Total Revenue-Economic Cost(explicit & implicit)

Economic Profit

A firm's revenue minus its explicit and implicit costs

Fixed Costs (FC)

Costs that remain constant as output changes

Variable Costs (VC)

Costs that change as output changes

Total Cost (TC)

Cost of all the inputs a firm uses in production

Average Fixed Cost (AFC)

Fixed Cost / Quantity

Average Variable Cost (AVC)

Variable Cost / Quantity

Average Total Cost (ATC)

Total Costs / Quantity

Marginal Cost (MC)

Additional cost of producing one more unit of a good or service

When Fixed Cost Changes

Only Total Cost(TC), Average Total Cost(ATC), and Average Fixed Cost(AFC) change; Marginal Cost(MC) remains the same

When Variable Cost Changes

Total Cost(TC), Average Total Cost(ATC), Average Fixed Cost(AFC) and Marginal Cost(MC) all change

Law of Diminishing Marginal Utility

As variable resources (workers) are added to fixed resources (machinery, tools) the additional output produced from each new worker will eventually fall

Stage I: Increasing Marginal Returns

Each additional worker is increasingly more productive, a given quantity of output can be produced with fewer variable inputs.
MP is increasing
TP is increasing
At an increasing rate

Stage II: Decreasing Marginal Returns

Each additional worker is less productive, a given quantity of output needs more variable inputs.
MP is decreasing
TP is increasing
At a decreasing rate

Stage III: Negative Marginal Returns

Workers are getting in each other's way
TP is decreasing
MP is negative

Law of Diminishing Marginal Returns

Result of fixed resources, not laziness

Long-Run

All resources are variable; No fixed costs

Economies of Scale

The cost advantages that a business obtain due to expansion. Average total costs falls as the quantity of output increases because of mass production techniques

Constant Returns to Scale

Long-run average total cost stays the same as the quantity of output changes, ATC is as low as it can get

Diseconomies of Scale

Average total cost rises as the quantity of output increases, the firm gets too big and difficult to manage

Perfect Competition

Many small firms,
identical products (substitutes),
easy to enter and exit the industry,
no need to advertise,
"Price takers"
no control over price

Price Taker

Firms sell their products at a price from the market

MR=D=AR=P

Marginal Revenue=Demand=Average Revenue=Price

Profit Maximizing Rule

MR=MC
Applies to all market structures,
only when price is above AVC
can be restated P = MC for perfectly competitive firms (b/c MR=P)

Short-Run

Goal is to make a profit, continue to produce until the additional revenue from each new output equals the additional cost.

Profit

MR is above ATC
Firms will enter

Loss

MR is below ATC
Firms will leave

Long-Run Equilibrium

Price = MC = Minimum ATC
Firms make a normal profit
TC = TR

Normal Profit

No incentive to enter or leave the industry

Shutdown Rule

A firm should continue to produce as long as the price is above the AVC curve
When the price falls below AVC, the the firms should minimize its losses by shutting down

Efficiency

Optimal use of society's scare resources
Perfect competition forces firms to use limited resources to the fullest
Inefficient firms have higher costs and are the first to leave industry
Perfectly competitive industries are extremely efficient

Productive Efficiency

The production of a good in a least costly way (minimum amount of resources are being used) (Long-Run)
Price = Minimum ATC

Allocative Efficiency

Producers are allocating resources to make the products most wanted by society,
Price = MC