Production, cost and perfect competition practice questions (AP Microeconomics)

Sample questions

All 5 free AP Microeconomics questions on this unit, from the free AP Microeconomics Practice Exam and the free AP Microeconomics Free-Response Practice Questions (FRQ) with Answers. Each answer is behind its own toggle; the whole paper, its PDF and the full answer key are on the exam page.

1. Question 12 marks · Diminishing marginal returns
   A bakery adds workers one at a time and finds that total output continues to rise, but by less with each additional worker. The bakery is experiencing:
   • A.
     diseconomies of scale
   • B.
     negative marginal product
   • C.
     diminishing marginal returns
   • D.
     falling total product
   • E.
     increasing marginal returns
   Show answerFrom the free AP Microeconomics Practice Exam →
2. Question 22 marks · Cost curves
   The marginal cost curve intersects:
   • A.
     ATC and AVC at their minimum points
   • B.
     ATC and AFC at their minimum points
   • C.
     AVC at its maximum point
   • D.
     ATC where AFC equals AVC
   • E.
     the demand curve at the profit-maximizing quantity
   Show answerFrom the free AP Microeconomics Practice Exam →
3. Question 32 marks · Shutdown rule
   A perfectly competitive firm faces a market price of 6 dollars. At its best possible output, average variable cost is 7 dollars and average total cost is 9 dollars. In the short run the firm should:
   • A.
     produce at a loss, because price covers part of fixed cost
   • B.
     exit the industry immediately
   • C.
     raise its price above 9 dollars
   • D.
     produce, because in the short run firms never shut down
   • E.
     shut down, because price is below minimum AVC
   Show answerFrom the free AP Microeconomics Practice Exam →
4. Question 46 marks · Perfect competition: short run vs long run
   Perfect competition. Wheat is produced in a perfectly competitive industry. The market price is 10 dollars per bushel. A representative farm is producing its profit-maximizing output, at which its average total cost is 8 dollars and rising marginal cost equals price.
   (a)

   Is the representative farm earning positive, zero, or negative economic profit in the short run? Explain.

   [2]
   (b)

   Explain what happens in this industry in the long run, and state the resulting market price relative to average total cost.

   [2]
   (c)

   A farmer complains that "zero economic profit means farming isn't worth doing." Briefly evaluate this claim.

   [2]
   Show answerFrom the free AP Microeconomics Practice Exam →
5. Question 510 marks · Perfect competition: costs, shutdown & long run
   Clearwater Bottling is one of many identical firms in the perfectly competitive market for cases of bottled spring water. The firm's total fixed cost is 24 dollars per day. Its total variable cost is 8 dollars for 1 case per day, 14 dollars for 2 cases, 18 dollars for 3 cases, 24 dollars for 4 cases, 32 dollars for 5 cases, 42 dollars for 6 cases and 54 dollars for 7 cases. The current market price is 9 dollars per case.
   (a)

   Using marginal analysis, determine the number of cases Clearwater should produce per day to maximize profit or minimize loss. Explain how you determined this.

   [2]
   (b)

   Calculate Clearwater's economic profit or loss at the output you found in part (a). Show your work.

   [1]
   (c)

   Should Clearwater continue to operate in the short run, or shut down? Explain, using numbers from your calculations.

   [2]
   (d)

   Explain how this market will adjust in the long run, and determine the long-run equilibrium market price and the daily output of each firm that remains in the industry. Show your work.

   [2]
   (e)

   In the long-run equilibrium you identified in part (d), is the market outcome allocatively efficient? Explain.

   [1]
   (f)

   Start from the long-run equilibrium in part (d) and assume the market price stays at that level in the short run. (i) The government now requires every firm to buy an operating license costing 12 dollars per day. Will Clearwater's profit-maximizing output increase, decrease or stay the same in the short run? Explain. (ii) Suppose that instead of the license the government imposes a tax of 2 dollars per case on producers. Determine Clearwater's new profit-maximizing output in the short run. Show your work.

   [2]
   Show answerFrom the free AP Microeconomics Free-Response Practice Questions (FRQ) with Answers →

Key terms

The definitions and formulas AP Microeconomics expects for production, cost and perfect competition, typeset as they appear on the paper.

Marginal product and diminishing marginal returns

Marginal product is the extra output from one more unit of an input. Beyond some point it falls as more of a variable input is added to a fixed input, which is why marginal cost eventually rises.

$$MP_L = \frac{\Delta Q}{\Delta L}$$

Cost curves

Marginal cost is the change in total cost per extra unit; average total cost is total cost per unit and splits into average fixed and average variable cost. MC crosses ATC and AVC at their minimum points.

$$MC = \frac{\Delta TC}{\Delta Q}, \qquad ATC = \frac{TC}{Q} = AFC + AVC$$

Economic versus accounting profit

Accounting profit subtracts explicit costs only; economic profit also subtracts implicit (opportunity) costs. Zero economic profit (normal profit) is the long-run outcome in perfect competition.

Profit-maximizing rule

Produce the quantity where marginal revenue equals marginal cost. For a price-taking firm $MR = P$, so the rule becomes $P = MC$.

$$MR = MC$$

Shutdown rule

In the short run a firm keeps producing at a loss as long as price covers average variable cost; it shuts down if price falls below minimum AVC, because then it loses more than its fixed costs.

$$\text{shut down if } P < \min AVC$$

Long-run equilibrium in perfect competition

Entry and exit drive economic profit to zero: price equals marginal cost and minimum average total cost, so the market is both allocatively and productively efficient.

$$P = MC = \min ATC$$

Economies and diseconomies of scale

Long-run average total cost falls as output expands (economies of scale), stays flat (constant returns) and eventually rises (diseconomies). The downward section explains natural monopoly.

Frequently asked questions

Other AP Microeconomics topics

• Basic economic concepts
• Supply and demand
• Imperfect competition
• Factor markets
• Market failure and the role of government

All AP Microeconomics topics · AP Microeconomics exam guide · All free practice exams