AP Microeconomics Unit 1: Basic Economic Concepts
Scarcity and the Foundations of Economic Systems
At the heart of the AP Microeconomics course outline lies the fundamental problem of scarcity: the tension between infinite human wants and finite resources. This unit establishes the groundwork for all subsequent economic analysis by defining resources as land, labor, capital, and entrepreneurship. Students must distinguish between positive economics, which describes "what is" through objective analysis, and normative economics, which addresses "what ought to be" based on value judgments. The exam frequently tests the ability to categorize economic systems—ranging from command economies to market economies—based on how they answer the three basic economic questions: what to produce, how to produce it, and for whom to produce. Understanding the incentive structure within these systems is critical, as it dictates how individuals respond to changes in costs and benefits.
Opportunity Cost and Production Possibilities Frontiers
The Production Possibilities Curve (PPC) serves as the primary graphical tool for illustrating scarcity, choice, and trade-offs. Candidates must master the distinction between a constant opportunity cost, represented by a linear PPC, and an increasing opportunity cost, represented by a concave (bowed-out) PPC. The latter occurs due to the Law of Increasing Opportunity Cost, which states that as more of a good is produced, the opportunity cost of producing an additional unit rises because resources are not perfectly adaptable to all uses. On the AP exam, students are often required to identify points of productive efficiency on the curve, inefficiency inside the curve, and unattainable combinations outside the curve. Furthermore, shifting the PPC outward through capital accumulation or technological progress is a recurring theme in both multiple-choice and free-response questions.
Comparative Advantage and Gains from Trade
One of the most mathematically rigorous portions of the AP Micro unit breakdown in Unit 1 involves calculating comparative advantage to determine the basis for trade. Students must differentiate between absolute advantage—the ability to produce more of a good with the same resources—and comparative advantage—the ability to produce a good at a lower opportunity cost. The exam utilizes two types of problems: "Output" problems (fixed resources, varying output) and "Input" problems (varying resources, fixed output). Using the Input-Output Method, candidates must calculate the per-unit opportunity cost for each producer. A critical exam skill is determining the "Terms of Trade," which must fall between the two producers' internal opportunity costs for a trade to be mutually beneficial. This concept explains why specialization leads to a global increase in consumption possibilities.
AP Micro Unit 2: Supply and Demand
The Law of Demand and Determinants of Demand
Unit 2 introduces the competitive market model, focusing first on the behavior of consumers. The Law of Demand establishes an inverse relationship between price and quantity demanded, driven by the Income Effect and the Substitution Effect. It is vital for students to distinguish between a "change in quantity demanded," which is a movement along the curve caused by a change in the good's own price, and a "change in demand," which is a shift of the entire curve. The AP Microeconomics topics list emphasizes five key demand shifters: tastes and preferences, the number of consumers, the price of related goods (substitutes and complements), income (normal vs. inferior goods), and consumer expectations. Mastery of these determinants allows students to predict how external shocks will impact consumer behavior before any market transactions occur.
The Law of Supply and Determinants of Supply
Supply analysis focuses on the producer's side of the market, where the Law of Supply dictates a direct relationship between price and quantity supplied. This upward-sloping relationship reflects the increasing marginal cost of production. Similar to demand, students must carefully separate movements along the supply curve from shifts of the curve. The primary supply shifters include input prices (resource costs), technology, taxes and subsidies, expectations of future prices, and the number of sellers. A common exam pitfall is confusing a change in demand with a change in supply; for instance, an increase in the price of a good does not shift its own supply curve but rather causes a movement to a higher quantity supplied. Understanding the Profit Motive is essential here, as firms will only increase output if the market price covers the rising marginal costs of production.
Market Equilibrium and Disequilibrium
Market equilibrium occurs at the intersection of the supply and demand curves, where the quantity demanded equals the quantity supplied ($Q_d = Q_s$). At this point, the market clears, and there is no tendency for the price to change. The AP exam frequently tests the effects of "Double Shifts," where both curves move simultaneously. Students must remember the rule of thumb: when two curves shift, either the equilibrium price or the equilibrium quantity will be indeterminate unless the magnitude of the shifts is specified. Furthermore, the curriculum covers disequilibrium states: a Surplus occurs when the price is above equilibrium ($Q_s > Q_d$), and a Shortage occurs when the price is below equilibrium ($Q_d > Q_s$). These concepts lead directly into the analysis of government-imposed price controls, such as price ceilings and price floors, and their resulting deadweight loss.
Price Elasticity of Demand and Supply
Elasticity measures the responsiveness of one variable to changes in another, providing a quantitative dimension to the AP Micro curriculum structure. The most critical measure is the Price Elasticity of Demand (PED), calculated as the percentage change in quantity demanded divided by the percentage change in price. Students must be able to classify demand as elastic ($|E| > 1$), inelastic ($|E| < 1$), or unit elastic ($|E| = 1$). A key application for the exam is the Total Revenue Test: if price and total revenue move in opposite directions, demand is elastic; if they move in the same direction, demand is inelastic. Other essential measures include Cross-Price Elasticity (identifying substitutes vs. complements) and Income Elasticity (identifying normal vs. inferior goods). Understanding these coefficients allows for a deeper analysis of tax incidence and the efficiency of market outcomes.
Unit 3: Production, Cost, and Perfect Competition
The Production Function and Diminishing Returns
Unit 3 shifts the focus to the internal operations of the firm, starting with the relationship between inputs and outputs. The Law of Diminishing Marginal Returns is the cornerstone of short-run production analysis; it states that as successive units of a variable resource (like labor) are added to a fixed resource (like capital), the marginal product of the variable resource will eventually decline. Students must be able to graph the Total Product (TP), Marginal Product (MP), and Average Product (AP) curves. A crucial relationship to remember for the exam is that when MP is above AP, AP must be rising, and when MP is below AP, AP must be falling. This mathematical reality dictates the shape of the firm's cost curves and explains why marginal costs eventually rise as production expands.
Short-Run and Long-Run Cost Curves
Understanding the structure of costs is vital for predicting firm behavior. In the short run, firms face both Fixed Costs (TFC), which do not change with output, and Variable Costs (TVC). The AP exam requires students to calculate and graph Average Total Cost (ATC), Average Variable Cost (AVC), and Marginal Cost (MC). The MC curve always intersects the ATC and AVC curves at their minimum points—a geometric necessity known as the "Productive Efficiency" point for the firm. In the long run, all costs are variable, and the firm experiences Economies of Scale (downward-sloping LRATC), Constant Returns to Scale, or Diseconomies of Scale (upward-sloping LRATC). Distinguishing between these stages is essential for explaining why some industries are dominated by large firms while others remain fragmented.
Profit Maximization in Perfect Competition
Perfect competition serves as the benchmark model for market efficiency. Firms in this structure are "price takers," meaning they have no market power and must accept the price determined by the industry. The firm's demand curve is perfectly elastic at the market price ($P = d = MR = AR$). To maximize profit, a firm must produce the quantity where Marginal Revenue equals Marginal Cost ($MR = MC$). On the exam, students must identify the three possible short-run scenarios: economic profit ($P > ATC$), economic loss ($P < ATC$), or normal profit ($P = ATC$). Additionally, the Shutdown Rule is a frequent assessment point: a firm should continue to operate in the short run even if it is losing money, provided the price stays above the minimum Average Variable Cost ($P > AVC$).
Firm and Market Supply in the Short and Long Run
In the long run, the absence of barriers to entry and exit ensures that perfectly competitive firms earn zero economic profit (normal profit). If firms are earning short-run profits, new firms will enter the industry, increasing market supply and driving down the price until profits are extinguished. Conversely, if firms face losses, some will exit, decreasing supply and raising the price. This process leads to Long-Run Equilibrium, where $P = MC = ext{minimum } ATC$. This state achieves both allocative efficiency (producing what society wants) and productive efficiency (producing at the lowest cost). Students must also understand the difference between constant-cost, increasing-cost, and decreasing-cost industries, as these determine the shape of the long-run industry supply curve.
AP Micro Unit 4: Imperfect Competition
Monopoly: Profit Max and Efficiency Loss
A monopoly exists when a single firm is the sole producer of a product with no close substitutes, often protected by high barriers to entry. Unlike perfectly competitive firms, a monopolist is a "price maker" and faces a downward-sloping demand curve. Consequently, the Marginal Revenue curve lies below the demand curve because the firm must lower the price on all previous units to sell an additional unit. The monopolist maximizes profit where $MR = MC$ but charges the price indicated by the demand curve for that quantity. This results in Deadweight Loss, as the firm produces less and charges more than a competitive market would. The exam often asks students to identify the area of consumer surplus, producer surplus, and deadweight loss on a monopoly graph to illustrate this market's allocative inefficiency.
Price Discrimination and Its Effects
Price discrimination occurs when a firm charges different prices to different consumers for the same product, based on their varying elasticities of demand, rather than differences in production costs. The AP curriculum focuses heavily on Perfect Price Discrimination (First-Degree), where the firm charges each consumer their maximum willingness to pay. In this theoretical scenario, the MR curve becomes identical to the demand curve, and the firm produces the allocatively efficient quantity where $P = MC$. However, there is no consumer surplus; it is entirely converted into producer surplus. Students must be able to compare this outcome to a standard monopoly, noting that while price discrimination increases the firm's profit and eliminates deadweight loss, it results in a vastly different distribution of welfare.
Monopolistic Competition Characteristics
Monopolistic competition is a market structure characterized by many firms, low barriers to entry, and Product Differentiation. Because products are not identical, firms have some control over price, resulting in a downward-sloping demand curve. In the short run, these firms can earn economic profits or losses, similar to a monopoly. However, in the long run, the ease of entry and exit ensures that firms earn only a normal profit. The long-run equilibrium for a monopolistically competitive firm occurs where the demand curve is tangent to the ATC curve. A key concept for the exam is Excess Capacity, which is the difference between the profit-maximizing output and the output at minimum ATC. This inefficiency is the "price" society pays for product variety.
Oligopoly and Game Theory Models
Oligopolies are markets dominated by a few large firms whose decisions are interdependent. This interdependence is analyzed using Game Theory, often represented in a payoff matrix. Students must master the concept of a Dominant Strategy—a move that is best for a player regardless of what the opponent does—and the Nash Equilibrium, where neither player has an incentive to deviate unilaterally from their chosen strategy. The curriculum also explores the temptation to collude and form a cartel to act like a monopoly. However, cartels are often unstable due to the incentive for individual members to "cheat" by increasing production. Understanding the kinked demand curve model and price leadership also helps explain the price rigidity often observed in oligopolistic markets.
Unit 5: Factor Markets
Derived Demand for Labor and Other Factors
Unit 5 shifts the perspective from the product market to the factor market, where households are the suppliers and firms are the demanders. The demand for a resource is a Derived Demand, meaning it is dependent on the demand for the final product the resource helps produce. For example, the demand for bakers is derived from the demand for bread. Students must understand that a firm's demand for labor is determined by the Marginal Revenue Product (MRP), which is the additional revenue generated by hiring one more worker. The MRP curve is the firm's demand curve for labor. Factors that shift this curve include changes in the price of the final product, changes in worker productivity, and changes in the prices of substitute or complementary resources.
Marginal Revenue Product and Hiring Decisions
To maximize profit in the factor market, a firm will hire workers up to the point where the Marginal Revenue Product equals the Marginal Resource Cost ($MRP = MRC$). In a perfectly competitive labor market, the MRC is equal to the market wage, as the firm is a "wage taker." This means the supply of labor to the individual firm is perfectly elastic (horizontal). On the exam, students are frequently asked to use a table of data to calculate the MRP of successive workers and determine the optimal hiring level. They must also apply the Least-Cost Rule, which states that to minimize costs, a firm should allocate its budget such that the marginal product per dollar spent on each resource is equal ($MP_L / P_L = MP_C / P_C$).
Market Power in Factor Markets
When a single firm is the sole hirer of labor in a town, it is a Monopsony. A monopsonist faces the entire upward-sloping market supply curve for labor. Because the firm must raise the wage for all existing workers to attract an additional worker, its Marginal Resource Cost (MRC) curve lies above the labor supply curve. Consequently, a monopsony hires fewer workers and pays a lower wage than a perfectly competitive labor market would. This creates a unique graphical model that students must be able to interpret. The exam also touches on the role of labor unions, which attempt to increase wages through collective bargaining or by restricting the supply of labor, effectively acting as a monopoly on the supply side of the factor market.
Economic Rent vs. Opportunity Cost
In the context of factor markets, it is essential to distinguish between the total payment to a factor and the portion that constitutes Economic Rent. Economic rent is the payment to a factor of production above the minimum amount necessary to keep that factor in its current use (its opportunity cost). This concept is most easily visualized when the supply of a resource is perfectly inelastic, such as land in a specific location. In such cases, the entire payment to the resource is considered economic rent. Understanding this distinction helps economists analyze the distribution of income and the impact of taxes on various factors of production. The AP exam may require students to identify these areas on a factor market graph, particularly in questions involving land or unique talent.
AP Microeconomics Unit 6: Market Failure and Government
Externalities: Positive, Negative, and Solutions
Market failure occurs when the free market fails to allocate resources efficiently, often due to Externalities. A negative externality exists when the production or consumption of a good imposes unintended costs on third parties, such as pollution. In this case, the Marginal Social Cost (MSC) exceeds the Marginal Private Cost (MPC), leading to overproduction. Conversely, a positive externality occurs when third parties benefit, such as with vaccinations, leading to underproduction because the Marginal Social Benefit (MSB) exceeds the Marginal Private Benefit (MPB). To correct these failures, the government can use Pigouvian Taxes to internalize negative externalities or subsidies to encourage positive ones. The goal is to shift the market to the socially optimal quantity where $MSB = MSC$.
Public Goods and the Free-Rider Problem
Public goods are defined by two characteristics: they are non-excludable (you cannot prevent non-payers from using them) and non-rivalrous (one person’s use does not diminish another’s). These traits lead to the Free-Rider Problem, where individuals have no incentive to pay for the good because they can enjoy its benefits for free. Because private firms cannot profitably produce public goods, the market fails to provide them at all, or provides them in insufficient quantities. Examples include national defense and street lighting. On the exam, students must distinguish between public goods, private goods, club goods, and common resources, and explain why government intervention through taxation and public provision is necessary to achieve an efficient outcome.
Government Policies: Taxes, Subsidies, and Regulation
The final section of the what is taught in AP Micro curriculum explores the tools government uses to address market failures and inequality. Beyond correcting externalities, the government uses progressive, regressive, and proportional tax structures to redistribute income. Students must understand the Lorenz Curve and the Gini Coefficient as measures of income inequality; a Gini coefficient of 0 represents perfect equality, while 1 represents perfect inequality. Additionally, the unit covers the impact of government regulations, such as antitrust laws designed to promote competition by breaking up monopolies or preventing mergers that would substantially lessen competition. Mastery of these policies allows candidates to evaluate the trade-offs between equity and efficiency that define modern economic debate.