AP Microeconomics: Unit 3 Terms - Definitions

Explicit Cost: A direct payment made to others for resources used in production. These are out-of-pocket expenses. (e.g., wages, rent, raw materials)

Implicit Cost: The opportunity cost of using resources owned by the firm. It's the income forgone by not using those resources in their best alternative use. (e.g., forgone salary from running your own business instead of working for someone else)

Accounting Profit: Total revenue minus explicit costs. It doesn't consider implicit costs.

Economic Profit: Total revenue minus both explicit and implicit costs. It reflects the true profitability of a firm by considering all opportunity costs.

Implicit Cost of Capital: The opportunity cost of using a firm's own capital. It's the income forgone by not investing that capital elsewhere.

Normal Profit: The minimum profit necessary to keep a firm in business in the long run. It's equal to zero economic profit and covers all explicit and implicit costs.

Principle of Marginal Analysis: Decisions are made by comparing the marginal benefit of an action with its marginal cost. An action should be taken if the marginal benefit exceeds the marginal cost.

Marginal Revenue (MR): The additional revenue generated by selling one more unit of output.

Optimal Output Rule: Produce the quantity of output where marginal revenue (MR) equals marginal cost (MC). This maximizes profit (or minimizes loss).

Marginal Cost Curve (MC): Shows the change in total cost resulting from producing one more unit of output. It typically slopes upward due to diminishing returns.

Marginal Revenue Curve (MR): Shows the relationship between quantity sold and marginal revenue. In perfect competition, it's a horizontal line equal to the market price.

Production Function: Shows the relationship between the quantity of inputs a firm uses and the quantity of output it produces.

Fixed Input: An input whose quantity cannot be changed in the short run. (e.g., factory size, machinery)

Variable Input: An input whose quantity can be changed in the short run. (e.g., labor, raw materials)

Long Run: A period of time in which all inputs can be varied. There are no fixed inputs.

Short Run: A period of time in which at least one input is fixed.

Total Product Curve (TP): Shows the relationship between the quantity of a variable input and the total output produced.

Marginal Product (MP): The increase in output resulting from employing one more unit of a variable input.

Diminishing Returns to an Input: As more of a variable input is added to a fixed input, the marginal product of the variable input eventually declines.

Fixed Cost (FC): Costs that do not vary with the quantity of output produced in the short run.

Variable Cost (VC): Costs that vary with the quantity of output produced.

Total Cost (TC): The sum of fixed costs and variable costs (TC = FC + VC).

Total Cost Curve (TC): Shows the relationship between the quantity of output produced and the total cost of production.

Average Total Cost (ATC): Total cost divided by the quantity of output (ATC = TC/Q).

Average Cost (AC): Often used interchangeably with ATC, referring to the cost per unit of output.

U-Shaped Average Total Cost Curve: ATC typically declines at low levels of output due to spreading fixed costs, reaches a minimum, and then rises due to diminishing returns.

Average Fixed Cost (AFC): Fixed cost divided by the quantity of output (AFC = FC/Q). AFC always declines as output increases.

Average Variable Cost (AVC): Variable cost divided by the quantity of output (AVC = VC/Q).

Minimum-Cost Output: The quantity of output at which average total cost is minimized.

Average Product (AP): Total output divided by the quantity of a variable input.

Average Product Curve (AP): Shows the relationship between the quantity of a variable input and the average product.

Long-Run Average Total Cost Curve (LRATC): Shows the relationship between output and average total cost when all inputs are variable.

Economies of Scale: LRATC decreases as output increases. Occurs when increasing all inputs proportionally leads to a more than proportional increase in output.

Increasing Returns to Scale: Same as economies of scale.

Minimum Efficient Scale (MES): The lowest level of output at which a firm can minimize its LRATC.

Diseconomies of Scale: LRATC increases as output increases. Occurs when increasing all inputs proportionally leads to a less than proportional increase in output.

Decreasing Returns to Scale: Same as diseconomies of scale.

Constant Returns to Scale: LRATC remains constant as output increases. Occurs when increasing all inputs proportionally leads to a proportional increase in output.

Sunk Cost: A cost that has already been incurred and cannot be recovered. It should not affect future decisions.

Price Taking Firm: A firm in a perfectly competitive market that cannot influence the market price. It must accept the market price as given.

Price Taking Consumer: A consumer who cannot influence the market price. They must accept the market price as given.

Perfectly Competitive Market: A market with many buyers and sellers, identical products, free entry and exit, and perfect information.

Perfectly Competitive Industry: An industry where all firms are price takers, producing identical products, with free entry and exit.

Market Share: The percentage of total market output produced by a single firm.

Standardized Product: Products that are identical or perfect substitutes.

Commodity: A standardized product that is typically traded in bulk.

Free Entry & Exit: Firms can easily enter or leave the market without facing significant barriers.

Barrier to Entry: Obstacles that make it difficult for new firms to enter a market. (e.g., patents, high start-up costs)

Price Taking Firm's Optimal Output Rule: Produce the quantity where price (P) equals marginal cost (MC). In perfect competition, P = MR, so P = MC is equivalent to MR = MC.

Break-Even Price: The price at which a firm earns zero economic profit (P = minimum ATC).

Shut-Down Price: The price at which a firm is indifferent between producing and shutting down in the short run (P = minimum AVC).

Short-run Firm Supply Curve: The portion of the firm's marginal cost curve that lies above the average variable cost curve.  

Industry Supply Curve: Shows the relationship between the market price and the total quantity supplied by all firms in the industry.

Short-Run Industry Supply Curve: The horizontal summation of all firms' short-run supply curves.

Long-Run Market Equilibrium: A situation where there is no tendency for firms to enter or exit the market, and economic profit is zero.

Long-Run Industry Supply Curve: Shows the relationship between the market price and the total quantity supplied by the industry in the long run.

Constant-Cost Industry: An industry where input prices remain constant as industry output increases. The long-run supply curve is horizontal.

Increasing-Cost Industry: An industry where input prices increase as industry output increases. The long-run supply curve is upward sloping.

Decreasing-Cost Industry: An industry where input prices decrease as industry output increases. The long-run supply curve is downward sloping.