AP Microecon 3.5 - 3.7 Study Guide

What is Marginal Cost?

the cost of producing one more unit of a good

What is Marginal Revenue?

the change in total revenue- the extra revenue- resulting from selling one more unit of output

What happens when MR>MC?

The firm could make additional profit by producing and selling more goods

What happens when MR < MC

The firm could have higher profits if it reduced the amount produced and sold because the cost of producing the last unit is more than the revenue it will generate for the firm.

Where is profit maximized for any firm?

Where MR=MC (always, always, always!!!)

What happens if MR never equals MC for a firm

Produce at the point where MR and MC are closest together, without MC being greater than MR.

What is the equation for profit?

Total Revenue - Total Cost = Profit

What is the equation for Total Revenue?

Price x Quantity

What is the equation for Total Cost?

fixed cost + variable cost

Where would a firm minimize its losses?

Where MR=MC

What is the Shut Down Rule?

In the short-run, if TR < VC a firm should shut down. This can also be stated as Price < AVC.

When MR=MC >ATC what should a firm do?

Stay open - they are making a profit

When MR=MC is between the ATC and AVC curves, what should a firm do?

Stay open - they are losing money, but minimizing losses by staying open to help pay down their fixed costs.

When MR=MC < AVC what should a firm do?

Shut down in the short run - every unit they produce they are losing money on

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

In the short run, at least one cost is fixed, (like rent). In the long run all costs are variable.

What is the rule for exiting a market?

If a MR=MC < ATC in the long run then a firm should exit the market

What are barriers to entry?

business practices or conditions that make it difficult for new firms to enter the market. Some examples include: patents and copyrights, government restrictions, start-up costs, brand identity

What are the characteristics of a perfectly competitive firm?

1. Price Taker

2. Lots of buyers and sellers

3. Selling identical products

4. No barriers to entry or exit

5. Zero econ profit in the long run

Why is the demand curve horizontal for a perfectly competitive firm?

Because there are so many sellers in the market selling identical goods, a firm has no market power. As a result, if they attempt to charge a higher price they will make zero sales. In other words, the demand for the firm's product is perfectly elastic, so the demand curve is horizontal. This is another way of saying the firm is a price taker - it doesn't get to determine the price it sells its good for.

What is MR PAR-D?

The horizontal curve on the perfectly competitive firm's graph. It shows Marginal Revenue = Price = Average Revenue = Demand. Because the price is constant (price taker), marginal revenue will also be constant, and so will average revenue (total revenue/Q). As explained elsewhere, this is also the demand curve for the firm's product.

What does a graph for a perfectly competitive market look like?

Regular supply and demand curve

What does a graph look like for a perfectly competitive firm look like?

U-shaped ATC curve, Nike swoosh MC Curve, Horizontal MRPARD.

Where do you find profit on a perfectly competitive firm's graph?

(P-ATC)*Q

Why do we use side by side graphs of the market and firm for perfect competition?

The market sets the price through supply and demand, which establishes the horizontal MRPARD curve for the firm.

If a perfectly competitive firm is making profit, what do we expect to happen to the market in the long run?

More firms will enter the market (no barriers to entry), which will cause the supply curve to shift to the right. This will cause price to decrease to the point where zero economic profit is made by firms in the long run.

If a perfectly competitive firm is losing money, what do we expect to happen to the market in the long run?

Firms will leave the market, which will cause the supply curve to shift to the left. This will cause price to increase to the point where zero economic profit is made by firms in the long run.

What is the shape of the market supply curve in the long run

Horizontal - supply and demand curves shift in the short run, but they will always come back to the price where zero economic profit is made in the long-run.

What is the supply curve for a perfectly competitive firm?

The MC curve above AVC (you will shut down if the price is below AVC).

What is meant by allocatively efficient?

Supply = Demand, which maximizes total surplus. For a perfectly competitive firm, the Demand Curve = MR and the Supply Curve = MC. As a result, they will always be allocatively efficient because they will always produce at the point where MR=MC.

What is meant by productive efficiency?

Produce at the point where ATC is minimized. In the long-run perfectly competitive firms always produce at this point because they are making zero economic profit (P=ATC), and also at the point where MR=MC. Therefore, MC=ATC, which is the low point on the ATC curve.