# AP Micro Unit 3 - Production, Cost, and the Perfect Competition Model

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## Description and Tags

### 53 Terms

1

Production

• The process by which a producer takes inputs (factors of production) and creates an output

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2

Fixed Costs

• The costs that aren’t affected by the quantity produced

• Examples:

• Rent

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3

Variable Costs

• The costs that are affected by the quantity produced

• Examples:

• Tomatoes to make pizza sauce

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4

Total Revenue

• Total amount of money a firm brings in

• TR = P * Q

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5

Accounting Profit

• The amount of money a business makes

• Just explicit costs

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6

Economic Profit

• Profit, including the opportunity cost

• Explicit and implicit costs

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7

Total Product (TP)

• How much a firm outputs in total

• Example: 2 workers produce 50 units, total is 50

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8

Average Product (AP)

• Divides total product by number of inputs

• Example: 2 workers produce 50 units, average is 25

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9

Marginal Product (MP)

• Additional output from adding one more input

• Helps us determine when we should stop adding more inputs - zero or negative, we stop

• Example: 2 workers produce 50 units, 3 workers produce 60 units - the 3rd worker’s MP was 10 units

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10

Law of Diminishing Marginal Product

• As we add more inputs, the additional product produced we get from each input will eventually diminish

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11

Returns to Scale

• Proportional increase in output from an increase in inputs

• Production doubles when input doubles

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12

Increasing Returns to Scale

• Production more than doubles with doubled input

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13

Decreasing Returns to Scale

• Production less than doubles with doubled input

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14

Short-Run

• Period of time where at least one input is fixed and cannot change

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15

Long-Run

• Period of time where no variables are fixed

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16

Accounting Costs

• Explicit costs paid by firms to use resources during the production process

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17

Economic Costs

• Sum of both the implicit costs (opportunity costs) and explicit costs of production

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18

Total Cost

• Total cost of producing some quantity of output

• Sum of the variable and fixed costs

• TC = VC + FC

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19

Cost Curves Graph

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20

Profit

• Difference of revenue and costs

• Profit = TR - TC

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21

Average Total Cost (ATC) Equation

• TC / Q

• AFC + AVC

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22

Average Variable Cost (AVC) Equation

• VC / Q

• ATC - AFC

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23

Average Fixed Cost (AFC) Equation

• FC / Q

• ATC - AVC

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24

Marginal Cost

• Additional cost of producing one more unit

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25

Total Cost, Variable Cost, Fixed Cost curves

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26

MC, ATC, AVC, AFC curves

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27

In the long run, all resources are…

flexible

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28

Long Run ATC (LRATC) Curve

• Short Run Total Cost Curves will shift in the Long Run as more is produced

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29

How do we find Long Run ATC (LRATC)?

• Take the lowest average total cost curve at each level of output (short run cost curves)

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30

LR ATC Car Scenario (to help understand)

• In the beginning of production, a factory does not use it’s full plant capacity and mass production is difficult, so there is a high cost producing less quantity

• As the firm continues production, it expands in capacity and can mass produce, lowering ATC

• As the firm expands, its output becomes larger than its plant capacity and is too big to manage, so costs rise again

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31

Economies of Scale

• Refers to the reduction in total cost-per-unit as a firm increases its production

• In this phase, the firm can reduce the total cost-per-unit by boosting its plant capacity and output

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32

Diseconomies of Scale

• Refers to the rise in total cost-per-unit as the firm increases its production

• In this phase, the firm would be better off reducing its plant capacity and output to lower per-unit costs

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33

Constant Returns to Scale

• Between Economies of Scale and Diseconomies of Scale

• In this phase, when the firm increases production, costs stay the same

• ATC is at its lowest

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34

Economies/Diseconomies of Scale

• Blue is Economies of Scale

• Green is Diseconomies of Scale

• Yellow is Constant Returns to Scale

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35

What does each color represent in the graph:

• Blue

• Yellow

• Green

• Blue = Economies of Scale

• Yellow = Constant Returns to Scale

• Green = Diseconomies of Scale

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36

Normal Profit

• When economic profit is zero - breaking even

• Our accounting profit is positive

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37

Economic losses

• When revenue is less than costs

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38

Supernormal profit

• When a firm experiences economic profits in the long run

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39

Theory of the Firm

• The primary goal of any firm, regardless of market structure, is to maximize profits

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40

Profit Maximizing Rule

• MR=MC

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41

Perfectly Competitive Market

• Many, small firms in the industry

• Firms are price takers, and have no control over the price of the goods they sell in the market

• Market is impacted when firms enter or exit

• Low barriers to entry

• Firms break even in the long run

• Products sold are identical

• No non-price competition

• All products are identical, so no need for advertising

• Firms are perfectly efficient in the long-run

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42

Perfect Competition Side by Side Graphs

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43

Perfect Competition Short Run Profit

• ATC and AVC curves are below MR=MC

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44

Perfect Competition Short Run Loss

• ATC curve is above MR=MC, and AVC curve is below MR=MC

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45

Perfect Competition Short Run Shut Down

• ATC and AVC curves are above MR=MC

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46

Perfect Competition Long Run Equilibrium

• ATC Curve is tangent to MR=DARP where MR=MC

• It is allocatively and productively efficient - perfectly efficient

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47

Perfectly Competitive Market

Short Run Shut Down Rule

• The firm should continue to operate as long as the price is equal to or above AVC

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48

Perfectly Competitive Market

When firms are earning economic loss in the short run, in the long run firms will…

leave the industry due to the lack of profit available

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49

Perfectly Competitive Market

When firms are earning economic profit in the short run, in the long run firms will…

enter the industry due to the potential profit available

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50

What is MR DARP?

MR = D = AR = P

• Market equilibrium is equal to marginal revenue

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51

Perfectly Competitive Market

When a firm enters the market, what will happen?

• Supply will shift right

• This will decrease price, driving MR DARP down

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52

Perfectly Competitive Market

When a firm leaves the market, what will happen?

• Supply will shift left

• This will increase price, raising MR DARP up

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53

Perfectly Competitive Market

In the long run, the market will shift towards…

equilibrium, or normal profits

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