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

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53 Terms

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Production
* The process by which a producer takes inputs (factors of production) and creates an output
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Fixed Costs
* The costs that aren’t affected by the quantity produced
* Examples:
* Rent
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Variable Costs
* The costs that are affected by the quantity produced
* Examples:
* Tomatoes to make pizza sauce
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Total Revenue
* Total amount of money a firm brings in
* TR = P \* Q
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Accounting Profit
* The amount of money a business makes
* Just explicit costs
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Economic Profit
* Profit, including the opportunity cost
* Explicit and implicit costs
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Total Product (TP)
* How much a firm outputs in total
* Example: 2 workers produce 50 units, total is 50
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Average Product (AP)
* Divides total product by number of inputs
* Example: 2 workers produce 50 units, average is 25
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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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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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Returns to Scale
* Proportional increase in output from an increase in inputs
* Production doubles when input doubles
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Increasing Returns to Scale
* Production more than doubles with doubled input
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Decreasing Returns to Scale
* Production less than doubles with doubled input
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Short-Run
* Period of time where at least one input is fixed and cannot change
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Long-Run
* Period of time where no variables are fixed
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Accounting Costs
* Explicit costs paid by firms to use resources during the production process
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Economic Costs
* Sum of both the implicit costs (opportunity costs) and explicit costs of production
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Total Cost
* Total cost of producing some quantity of output
* Sum of the variable and fixed costs
* TC = VC + FC
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Cost Curves Graph
knowt flashcard image
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Profit
* Difference of revenue and costs
* Profit = TR - TC
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Average Total Cost (ATC) Equation
* TC / Q


* AFC + AVC
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Average Variable Cost (AVC) Equation
* VC / Q
* ATC - AFC
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Average Fixed Cost (AFC) Equation
* FC / Q
* ATC - AVC
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Marginal Cost
* Additional cost of producing one more unit
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Total Cost, Variable Cost, Fixed Cost curves
knowt flashcard image
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MC, ATC, AVC, AFC curves
knowt flashcard image
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In the long run, all resources are…
flexible
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Long Run ATC (LRATC) Curve
* Short Run Total Cost Curves will shift in the Long Run as more is produced
* Short Run Total Cost Curves will shift in the Long Run as more is produced
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How do we find Long Run ATC (LRATC)?
* Take the lowest average total cost curve at each level of output (short run cost curves)
* Take the lowest average total cost curve at each level of output (short run cost curves)
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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
* 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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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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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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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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Economies/Diseconomies of Scale
* Blue is Economies of Scale
* Green is Diseconomies of Scale
* Yellow is Constant Returns to Scale
* Blue is Economies of Scale
* Green is Diseconomies of Scale
* Yellow is Constant Returns to Scale
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What does each color represent in the graph:

* Blue
* Yellow
* Green
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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Normal Profit
* When economic profit is zero - breaking even
* Our accounting profit is positive
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Economic losses
* When revenue is less than costs
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Supernormal profit
* When a firm experiences economic profits in the long run
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Theory of the Firm
* The primary goal of any firm, regardless of market structure, is to maximize profits
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Profit Maximizing Rule
* MR=MC
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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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Perfect Competition Side by Side Graphs
knowt flashcard image
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Perfect Competition Short Run Profit
* ATC and AVC curves are below MR=MC
* ATC and AVC curves are below MR=MC
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Perfect Competition Short Run Loss
* ATC curve is above MR=MC, and AVC curve is below MR=MC
* ATC curve is above MR=MC, and AVC curve is below MR=MC
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Perfect Competition Short Run Shut Down
* ATC and AVC curves are above MR=MC
* ATC and AVC curves are above MR=MC
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Perfect Competition Long Run Equilibrium
* ATC Curve is tangent to MR=DARP where MR=MC
* It is allocatively and productively efficient - perfectly efficient
* ATC Curve is tangent to MR=DARP where MR=MC
* It is allocatively and productively efficient - perfectly efficient
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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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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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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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What is MR DARP?
MR = D = AR = P

* Market equilibrium is equal to marginal revenue
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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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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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Perfectly Competitive Market

In the long run, the market will shift towards…
equilibrium, or normal profits