AP Microeconomics Unit 3 Cheatsheet: Production, Cost, and the Perfect Competition Model

Production function: relationship between inputs and outputs in short run (at least one fixed input) and long run (all inputs variable).

• Total Product (TP): total output at given input level
• Marginal Product (MP): change in TP from one more unit of input. MP = ΔTP / ΔInput
• Average Product (AP): output per unit of input. AP = TP / Input

Diminishing marginal returns: as one input increases (others fixed), MP eventually declines. Causes upward-sloping MC curve.

Specialization & division of labor reduce marginal costs by improving efficiency.

Total Cost (TC) = Fixed Cost (FC) + Variable Cost (VC)

• FC stays constant at all output levels, including zero
• VC changes with output

Per-unit costs:

• Average Fixed Cost (AFC) = FC / Q (always declining)
• Average Variable Cost (AVC) = VC / Q
• Average Total Cost (ATC) = TC / Q = AFC + AVC
• Marginal Cost (MC) = ΔTC / ΔQ (or ΔVC / ΔQ)

Cost curve shifts: Changes in variable-input prices or productivity shift MC, AVC, and ATC; changes in fixed costs shift AFC and ATC only.

Accounting Profit = Total Revenue − Explicit Costs (out-of-pocket payments)

Economic Profit = Total Revenue − (Explicit + Implicit Costs)

Implicit costs: opportunity costs not paid directly—financial capital cost, risk compensation, entrepreneur's time, foregone salary.

Normal Profit: economic profit = 0; firm earns just enough to cover all opportunity costs. Firm stays in market.

Key insight: Firms respond to economic profit, not accounting profit. Positive economic profit attracts entry; negative triggers exit.