1. AP Microeconomics Review Unit 3 (part 1)
Stater 2019

2. Production & Cost
Explicit & implicit costs; Accounting & economic profit; Product measures; Cost measures

3. Explicit v. Implicit Costs
Explicit costs: direct, purchased, out-of-pocket costs
Money is actually being exchanged
Ex: cost of raw materials, wages, rent, licenses/permits
Implicit costs: indirect, non-purchased costs
Next-best alternatives that have been forgone
Implicit costs ARE opportunity costs!

4. Accounting v. Economic Profit
Accounting profit =
Total revenue – Explicit costs
Economic profit =
Total revenue – Explicit costs – Implicit costs
(economic costs include both explicit & implicit costs)

5. Short-run v. Long-run
Fixed inputs: resources that go into the production process that cannot be changed in the short run
Variable inputs: resources that can be adjusted in the short run to meet changes in demand (labor is variable)
ALL inputs are variable in the long-run!
Plant Size (Capital)
Fixed Costs
Variable Costs
Entry/Exit of Firms
Short Run
Fixed
Some No
Long Run
Variable
None
All
Yes

6. Short-run Production Measures
Total Product (TP) - the total quantity/output of a good produced at each quantity of a resource employed (usually labor)
Marginal Product (MP) - The change in total product resulting from a change in the input (addition of a worker)
MP = (Change in TP) / (Change in # of Inputs)
***If labor is changing one unit at a time, then: MP = Change in TP
Average Product (AP) - Total product divided by the number of inputs employed (# of workers)
AP = TP / # of inputs
***Much less likely to use this one

7. Law of Diminishing Marginal Returns
As successive units of a variable resource are added to a fixed resource, the additional output will eventually decrease
It is not always more efficient to add more inputs
To determine when diminishing returns set in, you must calculate marginal product (if it’s not given) and look for the unit at which MP begins to decrease (NOT when it becomes negative)

8. Short-run Cost Measures
Total cost = Total fixed cost + total variable cost
Total fixed cost = Total cost – total variable cost
TFC is constant
Total variable cost = Total cost – total fixed cost
Marginal cost = (Change in total cost)/(change in Q of output)
Usually the change in Q of output is just equal to one, so you can disregard the denominator

9. Short-run Cost Measures (continued)
Average Total Cost (ATC) = TC / (Q of Output) or ATC = AFC + AVC
Average Variable Cost (AVC) = TVC / (Q of Output)
or AVC = ATC – AFC
Average Fixed Cost (AFC) = TFC / (Q of Output)
or AFC = ATC - AVC

10. Relationship between Marginal Product & Marginal Cost
These measures are inversely related:
Marginal cost & marginal product
Average variable cost & average product
Ex: as long as MP increases, MC is decreasing, and vice versa

11. Know what these cost curves will typically look like (for all market structures!)
Marginal cost (MC) looks like the Nike swoosh!
ATC will always be above AVC
ATC and AVC will always intersect MC at their minimums
Since TFC is constant, AFC will always decrease

12. Long-run Average Costs

13. Long-run Average Costs
If a firm is operating on the downward sloping portion of LRAC, it is experiencing economies of scale.
Long-run average costs are decreasing as plant size increases
If plant size doubles, output more than doubles
If a firm is operating on the flat portion of LRAC, it is experiencing constant returns to scale.
Long-run average costs remain constant as plant size increases
If plant size doubles, output also doubles
If a firm is operating on the upward sloping portion of LRAC, it is experiencing diseconomies of scale.
Long-run average costs are increasing as plant size increases
If plant size doubles, output less than doubles

14. Types of Efficiency (Really important to know these!!!)
Productive efficiency
Occurs when a firm is being as efficient with its resources as possible
Found on a graph where Price = Minimum Average Total Cost
Allocative efficiency
Occurs when the socially optimal amount of something is being produced
Found on a graph where Price = Marginal Cost

15. Perfect Competition
Graphical Analysis; Profit-maximization; Efficiency

16. Perfect Competition – first of four market structures
As much of this information is already typed out in the Unit 3 Key Concepts Outline (PDF), most of this section will consist of graphs/visuals

17. Golden Rule for Profit-Maximization in the Product Market
Golden Rule for Profit-Maximization in the Product Market (all market structures)
Regardless of the type of market structure, profit-maximizing firms will always produce the quantity where:
Marginal Revenue (MR) = Marginal Cost (MC)
This is easily identifiable on a graph – it’s where the MR and MC curves intersect.
When given data in a table instead, choose the quantity where MR = MC, or the quantity where they come as close as possible as long as MR > MC
Never produce a quantity with MC > MR

18. Identifying Profit Rectangles on Graphs (for any market structure)
Find the price at the profit-maximizing quantity, then go down or up to ATC, and over to the y-axis
If you had to go up to ATC, the firm is taking a loss because P < ATC
If you had to go down to ATC, the firm is making a profit because P > ATC
If P = ATC, there is no profit rectangle and the firm is earning zero economic profit (breaking even)

19. Side-by-side graph of a P.C. market & firm
*Profit rectangle is outlined in red

20. Side-by-side graph of a P.C. market & firm
*Loss rectangle is outlined in red

21. Side-by-side graph of a P.C. market & firm
*There is no profit rectangle because this firm will shut down, & its loss will be equal to TFC

22. What happens in the long-run?
Short-run profits attract firms to the industry (cause entry of firms in the long-run)
Short-run losses cause firms to leave the industry in the long- run
Entry & exit of firms causes the industry supply curve to shift (right for entry, left for exit), which affects the market price
Since P.C. firms are price takers, the firm’s MR = D = AR = P will shift up or down with the market price
Ultimately, in the long-run, perfectly competitive firms break even & experience both productive & allocative efficiency

23. Example: short-run profits attract firms to this industry in the long-run: