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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.