AP Microeconomics: Unit 3: Production Costs

Vocab and Practice

In microeconomics, the short run is defined as which of the following?

A A period that is less than one year

B A period that is between one year and four years

C A period that is too short for a firm to be able to change its level of output

D A period during which some inputs in a firm’s production process cannot be changed

E A period during which a firm’s fixed costs exceed its variable costs

D A period during which some inputs in a firm’s production process cannot be changed

The table above shows the short-run production function for picking apples. Based on the production data, which of the following statements about the marginal product of the fifth worker is true?

It is less than the marginal product of the third worker due to diminishing returns.

The relationship in the graph above best illustrates the economic concept of

diminishing marginal returns in production

The graph above shows the marginal product (MP) and the average product (AP) of labor for a firm that uses labor as the only variable input and hires its labor in a perfectly competitive market. At which quantity of labor does marginal cost change from decreasing to increasing?

L₂

Marginal cost is defined as the

change in total cost resulting from producing an additional unit of output

In the short run, which of the following is true of a firm's average total cost of production?

It is equal to average fixed cost plus average variable cost.

Which of the following is true about a firm's average variable cost?

It will equal average total cost when fixed costs are zero.

The following questions are based on the table below, which shows a firm’s average variable cost and average total cost.

$30

If the average variable cost of producing 5 units of a good is $100 and the average variable cost of producing 6 units is $150, then the marginal cost of increasing output from 5 to 6 units is

$400

When the marginal cost curve lies below the average total cost curve, it is true that as output increases

average total cost is decreasing

The graph above shows the cost curves for a competitive firm that produces 20 units of output. What are the total cost and the total fixed cost of producing 20 units of output?

Total Cost	Total Fixed Cost
$120	$20

The following questions refer to the graph below, which shows the cost curves for a profit maximizing, perfectly competitive firm.

average fixed cost of producing Q₁ units of output

The following questions are based on the table below, which gives cost information for a perfectly competitive firm.

$95.00

Which of the following MUST be true of the long run?

All factors of production are variable.

If the output of a firm doubles when the firm doubles all of its inputs, the firm must be experiencing

constant returns to scale

Economies of scale can be illustrated by

a decreasing long-run average total cost curve as a firm produces more output

If a firm's long-run average total cost increases as output increases, the firm is experiencing

diseconomies of scale

A farmer grows wheat using two inputs: labor and land whose prices are constant. If she doubles her inputs, she finds that the quantity of wheat produced more than doubles. Therefore, it must be true that in this output range her long-run average total cost curve is

downward sloping

Production Function

Relation between output (stuff produced) a firm can make w different combos of inputs (resources used)

Fixed input

Input whose quantity doesn’t change

Ex: The booth at McLaren’s — no matter how many people join, the size stays the same.

Variable input

Input whose quantity can change

Ex: Flour, butter, eggs

Marginal Product (MP)

Measures how much extra output you get when you add one more input

Change in Q / Change in L

MP graph

Inc, dec, then negative

MP increases

Specialization due to division of labor

MP decreases

diminishing marginal returns due to short run bc as more and more variable inputs added to fixed input 

Fixed input can be altered by

long run

Variable input can be altered by

short run

Diminishing marginal returns

As you keep adding input (people, drinks, whatever), each input adds less and less input to the total output (fun).

Ex: 

2 friends → chill night

4 friends → awesome night

7 friends → no seats, no bartender’s attention

Output

Quantity produced

Rental rate

The cost of using that stuff

Ex: what MacLaren’s pays for the building lease or what Barney pays for his tailor-made suits

Capital

Goods that are used to produce goods/services

MP = Slope of TP

MP increases —> TP increases w steep slope

MP decreases —> TP increases w not steep slope

MP = 0 —> TP is at max height

MP is negative —> TP decreases

Average product (AP)

Average output per input

AP graph

inc then dec

AP graph relation to MP (direct)

MP crosses the max of AP

MP above AP —> AP increases

MP below AP —> AP decreases

MP increases

TP increases w steep slope

MP decreases

TP increases w not steep slope

MP = 0

TP is at max height

MP is negative

TP is decreases

MP = AP

No change at maximum

Fixed Costs (FC)

Costs for fixed resources that DON’T change with the amount produced

Ex: Rent, insurance, 

Variable Costs (VC)

Costs for variable resources that DO change as more or less is produced

Ex: labor, raw materials

Total cost (TC)

Fixed Costs + Variable Costs

Marginal cost (MC)

The additional cost of an additional output or the difference in total cost from one unit of labor to the next.

Average fixed cost (AFC)

FC/Q

Average variable cost (AVC)

VC/Q

Average total cost (ATC)

TC/Q

AFC + AVC

= ATC

MC depends on MP

MC decreases = specialization (inc MP)

MC increases = diminishing returns (dec MP)

MC graph shape

like a checkmark

AFC is always

decreasing

AVC and ATC on a graph

decrease then increase

AVC and ATC get closer together

as AFC decreases

MC crosses through minimum of 

ATC and AVC

MC below ATC

ATC decreases

MC below AVC

AVC decreases

MC above ATC

ATC increases

MC above AVC

AVC increases

ATC and AVC graph shape

U-shape

MC = ATC

ATC is constant

TFC on a table

Is the same (not AFC)

Long run production 

• All inputs can be variable/altered

• No inputs fixed (resources)

• Factory capacity and size can be altered

• All costs are variable

Short run production

• Only variable inputs can be altered

• Some inputs are fixed

• Plant capacity is fixed

• There are both fixed and variable costs

Economies of scale

When producing more actually makes things cheaper per unit — efficiency goes up as you scale up.

Diseconomies of scale

When getting too big makes things more expensive per unit — coordination problems, chaos, inefficiency.

Constant returns to scale

When doubling your inputs doubles your output — efficiency stays the same.

Increasing returns to scale

Output is increasing at a faster rate than all inputs (Production cost decreases) Ex: bikes will more than double

Decreasing returns to scale

Output is increasing at a slower rate than all inputs (production cost is too much) Ex: bikes will less than double

Explicit costs

Money spent on materials, utilities, labor, rent,capital.

Ex: A car company has rubber, leather, computer software, and workers

Implicit costs

The money value of one’s opportunity cost

Ex: Teacher opens a restaurant (the income they are giving up by becoming a restaurant owner)

Why is long run important?

The Long-Run is used for planning and equilibrium. Firms use it to identify which factory size or number of factories results in the lowest per unit cost.

Long run ATC

Long Run ATC curve is made up of all the different short run ATC curves at various plant sizes

Increasing returns to scale

inputs double, output more than doubles

Decreasing returns to scale

if inputs double, output increases by less than double

Constant returns to scale

if inputs double, output also doubles. 

MR=MC Rule (Short run maximization)

1. Applies to all market structures

2. Price (where AE meets D) is above AVC

3. Restated P=MC for perfectly competitive firms  (bc MR=P)

If MR=MB (marginal benefit), then firms should produce at

MR=MC

Economies of Scale

Long run ATC decreases as output (mass production techniques) increases

Diseconomies of scale

Long run ATC increases as the firm gets too big

Constant return to scale (efficient scale)

Long run ATC is constant is as low as it can get

Minimum efficient scale

Helps determine the number of firms in a market

If MR is greater than / = MC,

They should keep producing (stop when they are maxed)

At profit max quantity TR>TC

Firm earns an economic profit

At profit max quantity TR=TC

Firm breaks even; earns a normal profit

At profit max quantity TR<TC

Firm earns an economic loss

Profit max Demand curve

P=D=MR=MC

Max profit graph is good

Above ATC

Max profit is in yellow

Keep producing but also at a loss

Mx profit is bad (shutdown)

Below minimum ATC

Short run supply curve

As price increases, quantity increases

Short run Supply curve

MC above AVC

Short run supply curve (MC and S)

MC increases, Supply decreases

MC decreases, Supply increases

No economic profit in long run

= normal profit = all firms break even

Equilibrium in a perfectly competitive market

Firm is extremely efficient

In the long run a firm will enter a perfect competitive market if

profit can be made

In the long run, firms will leave the perfectly competitive market if

the price drops and losses are incurred

Perfect competition D curve

• Total revenue increases at a constant rate

• MR is equal to AR (or Average Revenue)

Constant cost industry

New firms entering the market does not increase the costs for the firms already in the market.