A production function shows the relationship between the quantity of labor a firm hires and the quantity of output that number of workers produces.

Marginal Product 📈

The marginal product of labor is the change in total product divided by the change in quantity of labor. It represents the additional output produced by one more unit of labor.

The marginal product curve shows three phases of the Law of Diminishing Marginal Returns:

• Increasing Returns: The marginal product is rising.

• Diminishing Returns: The marginal product is falling.

• Negative Returns: The marginal product is negative.

Marginal Cost of Labor 💸

The marginal cost of labor is the wage paid to workers divided by the marginal product of labor. The marginal cost curve is a flipped, upside-down version of the marginal product curve.

Cost Categories 📊

There are two main categories of cost for businesses:

• Fixed Costs: Costs associated with production that don't change with output.

  • Examples: Capital, land

• Variable Costs: Costs that change with the quantity of output.

  • Examples: Labor, electricity

Total Costs 📈

Total Costs are the sum of fixed costs and variable costs.

Marginal Cost 💸

Marginal Cost is the change in total cost divided by the change in quantity of output.

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Average Variable Cost and Average Total Cost 📊

Average Variable Cost is the variable cost divided by the quantity of output.

Average Total Cost is the total cost divided by the quantity of output.

The average variable cost and average total cost curves intersect the marginal cost curve at its minimum point.

Productive Efficiency 📈

The quantity at the minimum point of the average total cost curve is called productively efficient, meaning it has the lowest average cost of production.

Long-Run Costs 📈

In the long run, all costs are variable. A change in production cost or fixed cost will shift the average total cost curve.

The long-run average total cost curve shows the relationship between the quantity of output and the average total cost in the long run.

• Economies of Scale: Average costs are falling as the firm expands.

• Constant Returns to Scale: Average costs are constant as the firm expands.

The long-run average total cost curve is downward sloping, indicating that average costs are falling as the firm expands.## Diseconomies of Scale and Profit Maximization 📈

Diseconomies of Scale

In the long run, as production is expanded, average costs begin to increase due to inefficient bureaucracy. This phenomenon is known as diseconomies of scale.

Profit Maximization

Firms seek to maximize profit, which is a basic assumption in AP economics. There are two types of profit:

• Accounting Profit: total revenue minus explicit costs

Accounting profit is the profit that is shown on the firm's financial statements.

• Economic Profit: total revenue minus explicit costs and implicit costs

Economic profit is the true profit that takes into account both explicit and implicit costs.

Production Decisions for Individual Businesses or Firms

Production decisions are made based on marginal analysis. The profit-maximizing quantity for a firm is found where marginal revenue equals marginal cost.

Perfect Competition 💰

Perfect competition is a market structure characterized by:

• Many firms selling identical products

• Low barriers to entry and exit

• No influence on price (price-takers)

• Zero economic profit in the long run

Profit Maximization in Perfect Competition

The profit-maximizing quantity is where marginal revenue equals marginal cost. The firm's average total cost curve determines whether it earns an economic profit, economic loss, or normal profit.

Long Run Equilibrium

In the long run, firms earn zero economic profit. The price from the market equals the minimum of the average total cost curve.

How Firms Get to Long Run Equilibrium

If firms earn economic profits, new firms enter the market, driving the price down and increasing quantity. If firms earn economic losses, some firms exit the market, driving the price up and decreasing quantity.

Efficiency in Perfect Competition

Perfectly competitive firms are:

• Allocatively Efficient: price always equals marginal cost

• Productively Efficient: produce at the minimum average total cost in the long run

Short Run Supply Curve

The firm's short run supply curve is based on the profit-maximizing quantity at different prices.

Increasing Cost Industries 📊

In increasing cost industries, an increase in the number of firms in the market shifts each individual firm's cost curves up.

Long Run Supply Curve in Perfect Competition

The long run supply curve is horizontal, as the price equals the minimum average total cost.