Untitled Flashcard Set
AP MICROECONOMICS · UNIT 3 STUDY GUIDE
Costs, Production &
Perfect Competition
Oct 13, 2026 · @Someone
Unit 3 keeps asking one question: how much should a firm produce, and is it making
money? Four tools answer it — opportunity cost, marginal analysis, cost curves, and
the P = MC rule. Covers Modules 52–59 (AP Microeconomics Unit 3).
How to use this guide: each section gives what you need to know and the traps that cost
points. Section 6 walks through one full problem. For every table, build the marginal column
(the change from row to row) before you answer anything.
01 Costs and Profit
Economists count every cost, including the value of what you gave up; accountants count
only the money that left your wallet.
Accounting profit = Total revenue − Explicit costs
Economic profit = Total revenue − Explicit costs − Implicit costs
Term Meaning Example
Explicit cost A payment of money for an input (labor,
rent, materials)
Wages, rent, tuition, utility bills
Implicit cost The value of the next-best alternative
given up; no money changes hands
The salary you could have earned
instead of going to school
Implicit cost of capital The opportunity cost of capital the
owner already has
Rent you could collect by leasing
out a building you own
Normal profit Economic profit of exactly zero; the
owner earns what they'd earn elsewhere
—
Unit 3 Study Guide: Costs, Production & Perfect Competition Page 1 of 7
Shortcut: accounting profit = economic profit + implicit costs. Moving from economic to
accounting profit, you add implicit costs back.
TRAPS
Implicit means no check is written. Forgone salary, forgone rent, and forgone interest are
implicit. Tuition, wages, rent paid, and fees are explicit.
Economic to accounting profit: add. Accounting profit = economic profit + implicit costs, so
accounting profit is the bigger number.
Owning something isn't free. Using your own building or savings still costs what you could
have earned renting or investing it.
02 Marginal Analysis
The optimal amount of any activity is the last unit where marginal benefit (MB) is at least
marginal cost (MC). "Marginal" always means one more unit.
MB = Δ Total benefit MC = Δ Total cost
1. Build the MB column: subtract each total from the one below it.
2. Compare each unit's MB to its cost (often the price per unit).
3. Your answer is the last unit where MB ≥ MC. Stop before the first unit where MB < MC.
If the activity is free (MC = 0), keep going
until MB turns negative. That is also where
total benefit peaks — not "as many as
possible."
If the price is above the first unit's MB, the
answer is zero.
TRAPS
Marginal, not total. Compare the price to the benefit of the next unit. A total benefit bigger
than the price doesn't mean the next unit is worth it.
"Free" doesn't mean "as many as possible." At a price of zero, stop when marginal benefit
turns negative.
If the price is above the first unit's MB, the answer is 0.
"From 3 to 4" means the 4th unit: total benefit at 4 minus total benefit at 3.
Unit 3 Study Guide: Costs, Production & Perfect Competition Page 2 of 7
03 Production
The short run and long run are defined by inputs, not by a number of months.
MP = Δ Total product ÷ Δ Labor AP = Total product ÷ Labor
Marginal product (MP): extra output from one more worker. MP of the 5th worker = TP at
5 − TP at 4.
Average product (AP): output per worker. Divide the total; don't subtract.
Diminishing marginal returns: adding more of a variable input to a fixed input eventually
makes MP fall. It only happens when some input is fixed, so it is a short-run idea.
Short run Long run
Inputs At least one fixed input (e.g., the factory); others
variable (e.g., labor)
All inputs are variable
Key idea Diminishing marginal returns Economies and diseconomies
of scale
TRAPS
MP subtracts, AP divides. MP of the 4th worker = TP at 4 − TP at 3. AP at 4 workers = TP at 4
÷ 4.
Don't answer with the total. The total output at 4 workers is never the marginal product of
the 4th worker.
Diminishing returns isn't about worse workers. Workers are identical; each new one just has
less equipment and space to work with.
Diminishing returns begin where MP first falls, even while MP is still positive.
Short run vs. long run is about inputs, not months. If any input is fixed, it's the short run.
Unit 3 Study Guide: Costs, Production & Perfect Competition Page 3 of 7
04 Long-Run Costs
In the long run every input is variable, so the firm chooses its size. The slope of the long-run
average total cost curve (LRATC) tells you what growing does to cost per unit.
Falling LRATC = economies of scale (often from specialization). Flat = constant returns to
scale. Rising = diseconomies of scale (often from coordination problems in very large firms).
LRATC
Economies of scale Constant returns Diseconomies of scale
Cost per unit
Output
Figure 1. LRATC · three regions of scale
TRAPS
Diminishing returns vs. diseconomies of scale. Both make costs rise. Diminishing returns is
short run (an input is fixed); diseconomies of scale is long run (every input changes).
Flat LRATC = constant returns to scale, not "constant total cost." Total cost still rises with
output; cost per unit stays the same.
Read the slope, not the height. Falling = economies, flat = constant returns, rising
= diseconomies.
Unit 3 Study Guide: Costs, Production & Perfect Competition Page 4 of 7
05 Perfect Competition
A perfectly competitive firm is a price taker: with many sellers of an identical product, it
sells any amount at the market price and can't raise it. So its demand curve is horizontal
(perfectly elastic), and P = MR = D = AR.
The profit-maximizing rule: produce where MR = MC. For a price taker that means P = MC.
From a table, produce every unit whose MC ≤ P.
TR = P × Q TC = ATC × Q Profit = (P − ATC) × Q
MC
ATC
AVC
Break-even (min ATC)
Shut-down (min AVC)
Produce · profit
Produce at a loss
Shut down
Price, cost
Quantity
Figure 2. MC, ATC and AVC · break-even and shut-down prices. The right-hand labels give the firm's short-run decision
when the market price sits in that band.
Unit 3 Study Guide: Costs, Production & Perfect Competition Page 5 of 7
Reading the graph: MC is the steepest curve and crosses AVC and ATC at their lowest
points. ATC always sits above AVC; the gap between them is average fixed cost, which
shrinks as output grows. To find total cost, read ATC at the profit-maximizing quantity
(where P = MC) and multiply by Q.
If price is... In the short run the firm... Economic profit
Above ATC Produces Positive
Equal to minimum ATC
(break-even price)
Produces Zero (normal profit)
Between AVC and ATC Produces anyway; revenue covers
variable cost and some fixed cost
Negative, but smaller than
fixed cost
Below minimum AVC (shut-
down price)
Shuts down, Q = 0 Negative, equal to fixed
cost
TRAPS
Firm demand vs. market demand. The market demand curve slopes down; one firm's demand
curve is horizontal at the market price.
Profit-max is MR = MC. It is not where MC is lowest and not where ATC is lowest.
MC often dips before it rises. In a table, keep producing while MC ≤ P; don't stop at the dip.
Total cost from a graph = ATC × Q at the profit-maximizing Q. Ignore the spot where the
price line happens to cross ATC.
Break-even = minimum ATC. Shut-down = minimum AVC. Don't swap them.
A loss doesn't mean shut down. If P is above AVC, producing loses less than shutting down,
which loses all fixed cost.
ATC is always above AVC. An answer that puts AVC above ATC is impossible.
Unit 3 Study Guide: Costs, Production & Perfect Competition Page 6 of 7
06 Worked Problem
Lena runs a perfectly competitive candle firm. The market price is ) 15 40 55 75 105 145 195
MC ($) — 25 15 20 30 40 50
Each MC is the change in total cost: 40 − 15 = 25, 55 − 40 = 15, and so on.
STEP 2 · FIXED COST
Total cost at zero output is all fixed cost, so FC = $15.
STEP 3 · APPLY P = MC
Produce every box whose MC ≤ $45. Boxes 1–5 cost 25, 15, 20, 30, 40; the 6th costs $50,
which is more than the price. MC dips at the 2nd box, so don't stop there. Q = 5 boxes.
STEP 4 · PROFIT
TR = P × Q = 45 × 5 = $225
TC at Q = 5 = $145
Profit = 225 − 145 = $80
Check the short-run decision: ATC at 5 boxes is 145 ÷ 5 = $29. The price ($45) is above ATC,
so Lena produces and earns a positive economic profit.
WHERE STUDENTS LOSE POINTS
Stopping at 4 boxes, or at the MC dip, instead of producing every box with MC ≤ P.
Producing the 6th box: its MC ($50) is above the $45 price.
Comparing price to total cost instead of marginal cost.