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Unit IIIA – Costs of Production and Firms in Competitive Markets (10-15% of AP Micro Exam) Objectives: NCEE Content Standard 2 – Effective decision making requires comparing the additional costs of alternatives with the additional benefits. Most choices involve doing a little more or a little less of something: few choices are “all or nothing” decisions. NCEE Content Standard 14 – Entrepreneurs are people who take the risks of organizing productive resources to make goods and services. Profit is an important incentive that leads entrepreneurs to accept the risks of business failure. NCEE Content Standard 15 – Investment in factories, machinery, new technology, and in the health, education, and training of people can raise future standards of living. Vocabulary: (Big Topics are in bold) Total Revenue Average Revenue Explicit Costs Implicit Costs Long Run Production Function Variable Inputs Average Product Law of Diminishing Product Marginal Returns Variable Costs Fixed Costs Efficient Scale Economies of Scale Diseconomies of Scale Sunk Costs Economics Profit Normal Profit Break-even Point Shutdown Point Characteristics of Perfect Competition market Marginal Revenue Short Run Fixed Inputs Marginal Product Total Costs Marginal Cost Returns to Scale Accounting Profit Profit Maximizing Rule Normal Profit Numbers and Formulas: Profit Maximizing Rule (MR=MC) Visuals: Perfect Competition Models (Market and Firm) Cost Curves Model Long Run Average Costs Model Profit, Loss, and Shutdown Model AP Microeconomics Activity Book (answers to Unit 3 M/C sample questions for Unit 3A) 1. E 11. D 2. C 12. C 3. D 13. D 4. C 14. B 5. C 15. B 6. D 16. C 7. E 18. C 8. A 38. E 9. E 10. E Unit IIIA Calendar: Monday November 28 Tuesday Wednesday 29 Unit 2B Test 30 Running a Business Hwk: Andrea’s Software worksheet due IN CLASS 5 6 Productivity Profit Hwk: Unit 3A RP due Tuesday, 12/15 Hwk: Read Module 55 12 Profit Maximization Hwk: Read p.568570, Module 58 and AP Micro Activity 3-5 Thursday December 1 Running a Business Hwk: Read Module 54 7 Friday 2 Productivity Hwk: Read Module 52 and AP Micro Activity 3-2 8 9 Cost Curves Short Run versus Long Run Short Run versus Long Run Hwk: AP Micro Activity 3-4 Hwk: Read Module 53 13 Perfect Competition Hwk: Read Module 56 and AP Micro Activity 3-3 14 Perfect Competition 15 Perfect Competition Unit 3A Test Hwk: Read Module 59 and AP Micro Activities 3-6 Hwk: Read Module 60 and AP Micro Activities 3-7, 3-8 Hwk: AP Micro Activity 3-9 16 What should you know at the end of this unit? Some of the opportunity costs, such as the wages a firm pays its workers, are explicit. Other opportunity costs, such as the wages the firm owner gives up by working in the firm rather than taking another job, are implicit. A typical firm’s production function (total product) gets flatter as the quantity of an input increases, displaying the property of diminishing marginal product. As a result, a firm’s total cost curve gets steeper as the quantity produced rises. Fixed costs are costs that do not change when the firm alters the quantity of output produced. Variable costs are costs that do change when the firm alters the quantity of output produced. Average total cost is total cost divided by the quantity of output. Marginal cost is the amount by which total costs rises if output increases by one unit. For a typical firm, marginal cost rises with the quantity of output. Average total cost first falls as output increases and then rises as output increases further. The marginal cost curve always crosses the average total cost curve at the minimum of average total cost. The firm’s marginal cost curve is its supply curve. Some costs are fixed in the short run but then become variable in the long run. As a result, when the firm changes its level of production, average total cost may rise more in the short run than in the long run. Because a competitive firm is a price taker, its revenue is proportional to the amount of output it produces. The price of the good equals both the firm’s average revenue and its marginal revenue. In a perfect competitive market, a firm chooses a quantity of output such that marginal revenue equals marginal cost (P=MC) to maximize profit. In the short run when a firm cannot recover its fixed costs, the firm will choose to shut down temporarily if the price of the good is less than average variable cost. In the long run, when the firm cannot recover both fixed and variable costs, it will choose to exit if the price is less than average total cost. In a market with free entry and exit, profits are driven to zero economic profits in the long run. In this long run equilibrium, all firms produce at the efficient scale, price equals average total cost, and the number of firms adjusts to satisfy the quantity demanded at this price. In the short run, an increase in demand raises prices and leads to profits, and a decrease in demand lowers prices and leads to losses. But if firms can freely enter and exit the market, then in the long run the number of firms adjusts to drive the market back to the zero economic profit equilibrium.