Use this review after studying all seven topics or taking the Unit 3 diagnostic.
Big ideas of the unit
- Production comes first. With a fixed input, MP rises with specialisation, then falls: diminishing marginal returns. (Topic 3.1)
- Costs mirror production. With one variable input, MC = wage ÷ MP and AVC = wage ÷ AP. Rising MP means falling MC; diminishing returns make MC rise. (Topic 3.2)
- Fixed costs never change MC. TFC is paid even at zero output; only variable input prices and productivity shift MC and AVC.
- The long run removes fixed inputs. Returns to scale shape LRATC; the MES compared with demand shows how many low-cost firms fit. (Topic 3.3)
- Firms respond to economic profit, which subtracts implicit costs. Zero economic profit is normal profit, not failure. (Topic 3.4)
- MR = MC (MC rising) picks output for every firm, giving the largest profit or smallest loss. (Topic 3.5)
- Short run: produce if P ≥ AVC; long run: stay only if P ≥ ATC. Fixed costs cancel out of the shutdown decision. (Topic 3.6)
- Perfect competition joins it all up. Price takers set MC = P; profits or losses cause entry or exit until P = minimum ATC. (Topic 3.7)
- The result is efficient: P = MC (allocative) and P = minimum ATC (productive), with prices as signals.
Key relationships and methods
| Idea | Rule or method | Topic |
|---|---|---|
| Marginal and average product | MP = ΔTP ÷ ΔL; AP = TP ÷ L; MP crosses AP at AP’s maximum | 3.1 |
| Short-run costs | TC = TFC + TVC; MC = ΔTC ÷ ΔQ = wage ÷ MP; ATC = AFC + AVC; MC cuts AVC and ATC at their minimums | 3.2 |
| Returns to scale | compare the % change in output with the equal % change in all inputs | 3.3 |
| Minimum efficient scale | smallest output at lowest LRATC; firms ≈ market quantity ÷ MES | 3.3 |
| Profit | accounting = TR − explicit; economic = accounting − implicit = (P − ATC) × q | 3.4 |
| Best output | produce while MR ≥ MC; for a price taker MR = P | 3.5 |
| Shutdown and exit | short run: shut down if P < min AVC; long run: exit if P < ATC expected | 3.6 |
| Long-run equilibrium | P = MR = MC = minimum ATC; zero economic profit | 3.7 |
These are original Marlbridge practice questions, not past exam questions. The rubrics are a suggested Marlbridge rubric, not official scoring. All firms, countries and data are fictional; a four-function calculator is enough.
Question 1 (multiple choice · mixed)
A firm’s only variable input is labour, at a constant wage. It produces where the average product of labour is at its maximum. Which statement is correct at this output?
- (A) Marginal cost is at its minimum.
- (B) Average variable cost is at its minimum, and marginal cost equals average variable cost.
- (C) Average total cost is at its minimum.
- (D) Total product is at its maximum.
Answer and explanation
Answer: (B). AVC = wage ÷ AP, so the highest AP gives the lowest AVC. MP = AP at AP’s peak, so MC (= wage ÷ MP) = AVC there.
- (A) MC is lowest where MP is highest, at a smaller output.
- (C) AFC is still falling there, so ATC’s minimum comes later.
- (D) TP is highest where MP = 0, well past AP’s peak.
Question 2 (multiple choice · mixed)
In the fictional country of Saltoria, the minimum efficient scale for railway carriages is 300 a year. If the price equals the lowest LRATC, Saltoria’s buyers would purchase 1,000 carriages a year. Which conclusion is most likely?
- (A) A firm making 150 carriages would have lower average cost, avoiding diseconomies of scale.
- (B) Entry will continue until hundreds of firms earn zero economic profit.
- (C) Each firm faces a horizontal demand curve, because carriages are produced at the lowest LRATC.
- (D) At most three firms can reach the lowest cost, so the market is likely to be concentrated, not perfectly competitive.
Answer and explanation
Answer: (D). 1,000 ÷ 300 ≈ 3.33, so only three firms can reach the MES. Perfect competition needs many small firms.
- (A) 150 carriages is in the range of economies of scale, where LRATC is higher.
- (B) A small entrant below the MES would have higher LRATC than its rivals.
- (C) Horizontal demand comes from many sellers of an identical product, not low costs.
Question 3 (multiple choice · mixed)
A price-taking firm makes a loss but is above its shutdown price. The government introduces either (I) a $2 tax on every unit sold or (II) a yearly licence fee that does not depend on output. Which is correct in the short run?
- (A) Tax II raises the shutdown price, because it raises average total cost.
- (B) Both taxes lower output, because both raise total cost.
- (C) Tax I lowers the firm’s profit-maximizing output and raises its shutdown price; tax II changes neither.
- (D) Neither tax changes output, because a price taker cannot pass a tax on to buyers.
Answer and explanation
Answer: (C). A per-unit tax is variable: MC and AVC shift up, so MC meets P at a lower output and minimum AVC rises. A fixed fee shifts only AFC and ATC.
- (A) The shutdown price is minimum AVC; a fixed fee raises the break-even price instead.
- (B) Only costs that change MC change the MR = MC output.
- (D) The price is unchanged, but the tax still raises MC, so output falls.
Question 4 (constructed response · mixed)
Greyfell Bindery sells notebooks at a market price it cannot change. It rents a binding machine for $150 a day (fixed) and hires workers at $80 a day.
| Workers | 0 | 1 | 2 | 3 | 4 | 5 | 6 |
|---|---|---|---|---|---|---|---|
| Total product (notebooks per day) | 0 | 10 | 30 | 56 | 76 | 90 | 98 |
(a) Calculate each worker’s marginal product and the marginal cost per notebook. (b) Explain the pattern in marginal cost. (c) At a price of $5, how many workers should Greyfell hire, and what is its daily result? Why does the 1st worker’s high MC not mean it should produce nothing? (d) Should it keep producing in the short run at $5? Use numbers. (e) The price rises to $8. Find the number of workers and the profit. If Greyfell is a typical perfectly competitive firm, what happens in the long run?
Worked solution and suggested Marlbridge rubric
(a) MC per notebook = wage ÷ MP.
| Worker | 1st | 2nd | 3rd | 4th | 5th | 6th |
|---|---|---|---|---|---|---|
| MP (notebooks) | 10 | 20 | 26 | 20 | 14 | 8 |
| MC per notebook ($) | 8.00 | 4.00 | 3.08 | 4.00 | 5.71 | 10.00 |
(b) Workers 1 to 3 specialise, so MP rises and MC falls. From the 4th, diminishing marginal returns set in: they share one fixed machine, so MP falls and MC rises.
(c) 4 workers, 76 notebooks. The 2nd to 4th workers’ notebooks cost less than $5; the 5th worker’s cost $5.71. TR = 5 × 76 = $380; TC = 150 + 320 = $470; result = −$90. The 1st worker’s MC ($8) is above $5, but MC is still falling; the totals confirm that 4 workers gives the best result.
(d) Yes. TR ($380) > TVC ($320), so P ($5) > AVC (320 ÷ 76 = $4.21). Producing loses $90; shutting down loses the $150 rent.
(e) The 5th worker’s notebooks ($5.71) now cost less than $8; the 6th’s ($10) do not. 5 workers, 90 notebooks; profit = 720 − 550 = $170. Economic profit attracts entry; supply shifts right and the price falls towards minimum ATC.
| Point | What earns it |
|---|---|
| 1 | All six MPs and MCs correct |
| 1 | Specialisation for falling MC and diminishing returns (fixed input) for rising MC |
| 1 | 4 workers (76 notebooks) using MR ≥ MC |
| 1 | −$90, and falling MC as the reason not to stop at the 1st worker |
| 1 | Produce: TR > TVC, −$90 against −$150 |
| 1 | 5 workers and $170 profit |
| 1 | Long run: entry, supply right, price falls |
Total: 7 points.
Question 5 (constructed response · mixed)
Bellmere Orchard is one of 300 identical firms in a perfectly competitive, constant-cost apple market. At the price of $24 a crate it sells 2,000 crates a season, where MC = $24. This season it pays $30,000 in variable costs and $12,000 for a land lease it cannot cancel. The owner also has $150,000 of her own money in equipment that cannot be sold this season; it could earn 8% elsewhere. Each firm’s minimum ATC is $25, at 2,400 crates. At $25, buyers want 576,000 crates a season.
(a) Calculate accounting profit and economic profit. (b) Calculate ATC and AVC at 2,000 crates. Should Bellmere produce this season or shut down? Give the result of each choice. (c) Explain what happens in the long run. Find the long-run price, output per firm and number of firms. (d) Explain why the new long-run equilibrium is efficient.
Worked solution and suggested Marlbridge rubric
(a) TR = 24 × 2,000 = $48,000. Accounting profit = 48,000 − 30,000 − 12,000 = $6,000. Implicit cost = 8% × 150,000 = $12,000. Economic profit = 6,000 − 12,000 = −$6,000.
(b) ATC = 54,000 ÷ 2,000 = $27.00; AVC = 30,000 ÷ 2,000 = $15.00. P > AVC, so produce: −$6,000. Shutting down still leaves the lease and tied-up money: −$24,000. The $18,000 gap equals TR − TVC.
(c) P < minimum ATC, so firms expect losses and some exit. Supply shifts left and the price rises to minimum ATC, $25. Each remaining firm produces 2,400 crates at zero economic profit. Firms = 576,000 ÷ 2,400 = 240, so 60 exit. Market output falls from 600,000, but each surviving firm produces more: the higher price moves it up its MC curve.
(d) P = MC = $25: the last crate is worth to buyers what it costs (allocative efficiency). P = minimum ATC: lowest average cost (productive efficiency).
| Point | What earns it |
|---|---|
| 1 | $6,000 accounting and −$6,000 economic profit |
| 1 | ATC $27.00 and AVC $15.00 |
| 1 | Produce: P > AVC, −$6,000 against −$24,000 |
| 1 | Exit from expected losses; supply shifts left |
| 1 | Long-run price $25 and 2,400 crates per firm |
| 1 | 240 firms (60 exit) |
| 1 | P = MC (allocative) and P = minimum ATC (productive) |
Total: 7 points.
Question 6 (constructed response · mixed)
Every paving-stone firm in the fictional country of Dunmara has these long-run total costs. Input prices do not change as a firm grows.
| Output (tonnes per week) | 100 | 200 | 300 | 400 | 500 |
|---|---|---|---|---|---|
| LRTC ($ per week) | 3,000 | 4,800 | 6,000 | 8,000 | 11,000 |
Market demand is Q = 60,000 − 1,500P, where Q is tonnes per week and P is dollars per tonne.
(a) Calculate LRATC at each output and state the MES. (b) Using percentage changes, identify the returns to scale from 100 to 200, 300 to 400, and 400 to 500 tonnes. (c) The market is perfectly competitive. Find the long-run price, the quantity, and the number of firms if each produces at the MES. Is perfect competition a reasonable model here? (d) Wages and rents rise, so every firm’s long-run cost is 10% higher at every output. Find the new long-run price, quantity and number of firms at the MES. What happens to the MES?
Worked solution and suggested Marlbridge rubric
(a) LRATC = LRTC ÷ output: $30, $24, $20, $20, $22 per tonne. MES = 300 tonnes, the smallest output at the lowest LRATC.
(b) 100 → 200: output +100%, cost +60%: increasing returns. 300 → 400: both +33.3%: constant. 400 → 500: output +25%, cost +37.5%: decreasing.
(c) Long-run price = minimum LRATC = $20. Q = 60,000 − 1,500 × 20 = 30,000 tonnes. Firms at the MES = 30,000 ÷ 300 = 100. Yes: the MES is only 1% of the market, so many firms can reach the lowest cost.
(d) Minimum LRATC is now $22, the new long-run price. Q = 60,000 − 33,000 = 27,000 tonnes; firms at the MES = 90. The MES is unchanged at 300 tonnes: input prices shift LRATC; they are not a diseconomy of scale.
| Point | What earns it |
|---|---|
| 1 | All five LRATC values |
| 1 | MES = 300 tonnes |
| 1 | Three returns to scale, each with percentage changes |
| 1 | Price $20 and 30,000 tonnes |
| 1 | 100 firms; small MES share, so perfect competition fits |
| 1 | Price $22, 27,000 tonnes, 90 firms |
| 1 | MES unchanged; input prices shift the curve |
Total: 7 points.
Question 7 (constructed response · mixed)
A perfectly competitive market for printed tote bags is in short-run equilibrium at $9 a bag. A typical firm produces 500 bags a week, where ATC is $7. Minimum ATC is $6, at 400 bags.
(a) Draw labelled side-by-side graphs of the market and the typical firm. Show the price, the firm’s output and the firm’s economic profit. (b) Calculate the economic profit. Explain why accounting profit must be larger. (c) The industry has constant costs. Explain the long-run adjustment, state the long-run price and each firm’s output, and show them on your graphs. (d) Suppose instead that industry growth raises the price of printing ink, so minimum ATC rises to $7. State the long-run price and the shape of the long-run supply curve.
Worked solution and suggested Marlbridge rubric
(a) Market: price ($ per bag) against quantity, D and S₁ crossing at $9. Firm: the same price scale against output q; P = MR = d at $9 meets rising MC at q = 500. U-shaped ATC is lowest ($6) at 400 and is $7 at 500. Shade the rectangle from $7 to $9, width 500.
(b) (9 − 7) × 500 = $1,000 a week. ATC includes implicit costs; accounting profit subtracts only explicit costs, so it is larger by the implicit costs.
(c) Profit and no barriers attract entry. S shifts right (S₂) and the price falls to minimum ATC, $6. Each firm moves down its MC curve to 400 bags, where P = MC = minimum ATC and economic profit is zero. Market quantity rises because there are more firms.
(d) The long-run price is the new minimum ATC, $7. Expansion bids up an input price, so this is an increasing-cost industry with an upward-sloping long-run supply curve. Firms still end at zero economic profit.
| Point | What earns it |
|---|---|
| 1 | Labelled side-by-side graphs sharing one price scale |
| 1 | P = MR = d at $9 meeting MC at q = 500, above ATC |
| 1 | Profit rectangle and $1,000 |
| 1 | Accounting profit larger: ATC includes implicit costs |
| 1 | Entry, S shifts right, price falls to $6 |
| 1 | Firm output 400 at zero economic profit, shown |
| 1 | $7; upward-sloping long-run supply from rising input prices |
Total: 7 points.
How did you do?
Questions 1 to 3 are worth 1 point each and Questions 4 to 7 are worth 7 each: 31 in all. Check which ideas cost you points:
- Production and cost (Q1, Q4): Topic 3.1 checklist and Topic 3.2 checklist.
- Long-run costs and MES (Q2, Q6): Topic 3.3 checklist.
- Economic profit (Q5, Q7): Topic 3.4 checklist.
- MR = MC (Q3, Q4): Topic 3.5 checklist.
- Shutdown, entry and exit (Q3, Q4, Q5): Topic 3.6 checklist.
- Perfect competition (Q5, Q6, Q7): Topic 3.7 checklist.
Not taken the Unit 3 diagnostic yet? It shows which topic to revisit first.