Topic Outlines

All material from AP Central


I. Basic Economic Concepts

The study of microeconomics requires students to understand that, in any economy,
the existence of limited resources along with unlimited wants results in the need
to make choices. An effective AP course, therefore, begins by introducing the
concepts of opportunity costs and trade-offs, and illustrates these concepts by using
the production possibilities curve or other analytical examples. The course can then
proceed to a consideration of how different types of economies determine which
goods and services to produce, how to produce them and to whom to distribute
them. It is also important that students understand why and how specialization and
exchange increase the total output of goods and services. Students need to be able
to differentiate between absolute and comparative advantage, to identify comparative
advantage from differences in opportunity costs and to apply the concept of
comparative advantage, in order to determine the basis under which mutually
advantageous trade can take place between countries. Specific examples from actual
economic situations can be used to illustrate and reinforce the principles involved.
The importance of property rights, the role of incentives in the functioning of free
markets and the principle of marginal analysis should be highlighted.

II. The Nature and Functions of Product Markets

The study of the nature and functions of product markets falls into four broad areas:
supply and demand models, consumer choice, production and costs and theory of
the firm.
A well-planned AP course requires an analysis of the determinants of supply and
demand and the ways in which changes in these determinants affect equilibrium
price and output. In particular, the course helps students make the important
distinction between movements along the curves and shifts in the curves. The course
also emphasizes the impact of government policies, such as price floors and ceilings,
excise taxes, tariffs and quotas on the free-market price and quantity exchanged. The
concepts of consumer surplus and producer surplus should also be introduced.
Students are expected to comprehend and apply the concepts of elasticity, including
calculating price, cross-price, income elasticities of demand and the price elasticity of
The next area covered in the course is the theory of consumer choice. Students
should gain an understanding of the basic postulates underlying consumer choice:
utility, the law of diminishing marginal utility and utility-maximizing conditions, and
their application in consumer decision-making and in explaining the law of demand.
By examining the demand side of the product market, students learn how incomes,
prices and tastes affect consumer purchases. Here it is important that students understand
how to derive an individual’s demand curve, how individual and market demand
curves are related and how the income and substitution effects explain the shape of
the demand curve.

The third area covers production and cost analysis both in the short run and in
the long run. This section begins with an introduction of the short-run production
function, describing the relationship between the quantity of inputs and the quantity
of output. Within the context of the production function, students should understand
average and marginal products as well as the law of diminishing marginal returns.
Students learn the link between productivity and costs and examine the relationships
among the short-run costs: total, average and marginal. With an introduction of
the concept of cost minimization, this section also includes a discussion of long-run
costs and an examination of economies and diseconomies of scale, as well as returns
to scale.
The fourth area covers the behavior of firms in different types of market structures.
This section begins with the definition of profits, making the distinction between
accounting and economic profits, and establishing the profit-maximizing rule, using
marginal analysis. In covering perfect competition, the course focuses on determining
short-run and long-run equilibrium, both for the profit-maximizing individual firm
and for the industry, and on the equilibrium relationships among price, marginal
and average revenues, marginal and average costs, and profits. Students should
understand the adjustment process to long-run equilibrium.
In considering the market behavior of a monopolist, students identify and examine
the sources of monopoly power and understand the relationship between a monopolist’s
demand curve and its marginal revenue curve. Students learn how a monopoly’s total
revenue changes along its demand curve as price varies. Having learned the behavior
of monopolies and perfect competition, students should compare a monopolist’s price,
level of output and profit with those of a firm operating in a perfectly competitive
market. By paying particular attention to the concept of allocative efficiency, students
learn how and why competitive markets achieve an efficient allocation of resources,
whereas monopolists do not. The concept of deadweight loss is a good device to show
the efficiency loss due to monopoly. The model of price discrimination provides
another dimension of monopoly behavior that students need to learn and understand.
In covering oligopoly, the course stresses the interdependency of firms and
their tendency to collude or to form a cartel. With a simple payoff matrix, the basic
game-theory model should be used to enhance a student’s understanding of the
interdependent behavior of firms in an oligopolistic market and identification of
dominant strategies.
Finally, the course considers the market structure of monopolistic competition and
highlights the importance of product differentiation and the role of advertising in
the behavior of firms. The course then proceeds to examine firm behavior in the
short run and in the long run and the existence of excess capacity and its implication
for efficiency.


III. Factor Markets

In this section of the course, students also apply the concepts of supply and demand
to markets for factors such as labor, capital and land. Students analyze the concept
of derived demand, understand how a factor’s marginal product and the marginal
revenue product affect the demand for the factor, and consider the role of factor

prices in the allocation of scarce resources. When the markets for different factors are

considered separately, most attention should be given to the labor market,
particularly labor supply and wage and employment determination. Although the
course may emphasize perfectly competitive labor markets, the effect of deviations
from perfect competition, such as minimum wages, unions, monopsonies and
product market monopolies, can also be considered. The principles studied in the
analysis of the labor market should be applied to the markets for land and capital to
explain the determination of economic rent and the price of capital. By studying the
determination of factor prices, students gain an understanding of how the market
determines the distribution of income and the sources of income inequality in a
market economy.

IV. Market Failure and the R ole of Government

It is important for students to understand the arguments for and against government
intervention in an otherwise competitive market. Students examine the conditions
for economic efficiency, using the marginal social benefit and marginal social cost
principle, and the ways in which externalities, public goods and the market distribution
of income create market failures even in competitive free-market economies. In
addition, students are expected to study the effectiveness of government policies such
as subsidies, taxes, quantity controls and public provision of goods and services, which
are designed to correct market failures and achieve economic efficiency. It is also
important both to emphasize that monopolies can cause market failures when they use
their market power to engage in behavior that restrains competition and to examine the
government’s attempt to solve such problems by using antitrust policy and regulations.
Although there is not a generally accepted standard for judging the equity of an
economy’s income distribution, a well-designed course will incorporate key measures
of income distribution (Lorenz curve and Gini coefficient) and examine the impact of
government tax policies and transfer programs, both on the distribution of income and
on economic efficiency.



Product Markets

  • Consumer and Producer Surplus (Krugman, Ch 4) (Mankiw, Ch 7)
  • Elasticity of Income and Cross-Price Elasticity (Krugman, Ch 4) (Mankiw, Ch 5)
  • Taxes and deadweight loss (Krugman, Ch 7) (Mankiw, Ch 6)

Market Structures

  • Demand and cost curves for each market structure (Krugman, Ch 13 to 16) (Mankiw, Ch 14 to 17)
  • Short run and long run equilibrium for each market structure (Krugman, Ch 13 to 16) (Mankiw, Ch 14 to 17)
  • Additional topics (collusion and game theory, price discrimination, deadweight loss, allocative efficiency) (Krugman, Ch 13 to 16) (Mankiw, Ch 14 to 17)

Factor Markets

  • Derived factor demand (Krugman, Ch 20) (Mankiw, Ch 18)
  • Perfectly competitive labour markets (Krugman, Ch 20) (Mankiw, Ch 18)

Market Failures and the Role of Government

  • Models of income inequality (Gini coefficient, Lorenz curve) (Krugman, Ch 20) (Mankiw, Ch 20)


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