Ten lessons that follow the six course units: decisions, supply and demand, costs, market structures, factor markets and market failure, with graph and free-response habits.
A reasoning guide to AP Microeconomics, not a full course. Unit order and weightings follow the College Board course page; all numbers in examples are invented for practice.
Basic algebra and graph reading.
Course outline
Scarcity, marginal thinking and gains from trade
Apply opportunity cost and marginal analysis to individual decisions and explain gains from specialisation.
Demand, supply and equilibrium
Shift demand and supply correctly and predict price and quantity changes.
Consumers, surplus and the effects of taxes
Measure consumer and producer surplus and trace taxes, subsidies and trade restrictions.
Production, costs and the short run
Use marginal product and cost curves to find output and explain the shapes of cost curves.
Perfect competition
Find the profit-maximising output and describe short-run and long-run outcomes for price takers.
Monopoly and monopolistic competition
Analyse market power, pricing and efficiency for firms with downward-sloping demand.
Oligopoly and game theory
Use payoff matrices to find dominant strategies and Nash equilibria and explain collusion.
Factor markets: labour and resources
Derive demand for labour from marginal revenue product and find the hiring rule.
Market failure: externalities and public goods
Identify externalities and public goods and judge policies that fix them.
Exam day: microeconomics graphs and free response
Use the exam format and graph habits to score on the free-response questions.
Sources and curriculum note
Reviewed October 5, 2026. Confirm format on the College Board site for your exam year.
Read every lesson below. The interactive reader above contains the same explanations, with visual tools and quizzes.
1. Scarcity, marginal thinking and gains from trade
Learning goal: Apply opportunity cost and marginal analysis to individual decisions and explain gains from specialisation.
Microeconomics studies the choices of households, firms and governments. Scarcity forces trade-offs, and the opportunity cost of a choice is the value of the best alternative given up. Rational decision makers compare marginal benefit with marginal cost and expand an activity while the marginal benefit is at least the marginal cost. Costs already paid and not recoverable are sunk costs and should not change a forward-looking decision.
Explicit costs are payments made; implicit costs are the value of resources the owner supplies, such as the owner's own time. Economic profit is revenue minus both kinds of cost, while accounting profit subtracts only explicit costs. A business can earn a positive accounting profit and a negative economic profit if the owner could have earned more elsewhere. This distinction returns in the cost and market structure lessons.
Comparative advantage explains why trade helps both sides. A producer has a comparative advantage in a good when its opportunity cost of making it is lower than another producer's. Specialising by comparative advantage and trading at a price between the two opportunity costs leaves both better off than producing everything alone. The numbers used here are invented for practice. Absolute advantage, producing more with the same inputs, does not decide who should specialise.
A production possibilities curve shows the efficient combinations of two goods. Points inside it waste resources, points outside are unreachable, and a bowed-out shape shows increasing opportunity cost. Demand, supply and markets then allocate scarce goods through prices, which is the subject of the next unit. On an exam, always compute opportunity cost as what is given up divided by what is gained, and name which producer has the lower figure.
Worked example
A student could earn 90 working on a day when she instead attends a 40 class (invented numbers). The class has a 40 fee. What is the opportunity cost of attending?
Explicit cost: the 40 fee.
Implicit cost: the 90 of forgone earnings.
Opportunity cost combines both: 130.
If the class is worth less than 130 to her, she should skip it.
Practice problem and solution
A producer gives up 12 shirts to make 4 hats. What is the opportunity cost of one hat in shirts?
12/4 = 3 shirts per hat.
Mental model: Compare marginal benefit and cost. Ignore sunk costs. Specialise by comparative advantage.
Common trap: Mixing up absolute and comparative advantage.
2. Demand, supply and equilibrium
Learning goal: Shift demand and supply correctly and predict price and quantity changes.
Unit 2 carries 20% to 25% of the multiple-choice section. The law of demand says that, other things equal, a higher price lowers the quantity demanded. A price change moves you along the curve; a change in income, tastes, expectations, population or the prices of related goods shifts the whole curve. For a normal good demand rises with income, while for an inferior good it falls. Substitutes move in the same direction as the other good's price and complements in the opposite direction.
Supply slopes upward because higher prices make production worth the higher marginal cost. Supply shifts when input costs, technology, the number of sellers, expectations or taxes and subsidies change. A cost-saving technology shifts supply right; a per-unit tax shifts it left. The market equilibrium is the price where quantity demanded equals quantity supplied. A price above equilibrium creates a surplus that pushes the price down; a price below it creates a shortage that pushes it up.
To predict an outcome, decide first which curve moves and in which direction, then read the effect on price and quantity. A demand increase raises both price and quantity. A supply increase lowers price and raises quantity. If both curves shift, one variable is determinate and the other depends on the relative sizes. For instance, when both demand and supply increase, quantity rises but price can go either way. Always say 'ambiguous' where the model cannot tell.
Price controls interfere with equilibrium. A price ceiling below equilibrium causes a shortage, and a price floor above equilibrium causes a surplus. Elasticity measures how responsive quantity is to price. Price elasticity of demand is the percent change in quantity demanded divided by the percent change in price. If the absolute value is above 1, demand is elastic; below 1 it is inelastic. When demand is elastic, a price rise lowers total revenue; when inelastic, it raises total revenue.
Worked example
Price rises from 10 to 12 and quantity demanded falls from 100 to 90 (invented). Find the price elasticity of demand using simple percent changes.
Percent change in quantity: −10/100 = −10%.
Percent change in price: 2/10 = 20%.
Elasticity = −10% / 20% = −0.5.
The absolute value is 0.5, so demand is inelastic and total revenue rises with the price.
Practice problem and solution
Quantity demanded falls 20% when price rises 10%. What is the absolute value of price elasticity?
20/10 = 2, so demand is elastic.
Mental model: Move along for price changes, shift for everything else.
Common trap: Calling a price change a shift in demand.
3. Consumers, surplus and the effects of taxes
Learning goal: Measure consumer and producer surplus and trace taxes, subsidies and trade restrictions.
Consumer surplus is the gap between what buyers are willing to pay and what they actually pay, shown on a graph as the area under the demand curve and above the price. Producer surplus is the gap between the price sellers receive and their marginal cost, the area above the supply curve and below the price. In a competitive market at equilibrium, total surplus is at its maximum, which is the sense in which the market outcome is efficient.
A per-unit tax drives a wedge between what buyers pay and what sellers keep. The quantity falls, buyers pay more and sellers receive less. Who bears more of the burden depends on elasticity: the more inelastic side bears more. The tax revenue is the tax per unit times the new quantity. The lost surplus on trades that no longer happen is the deadweight loss, a triangle on the graph, and it grows with the square of the tax size, so a doubled tax roughly quadruples it.
A subsidy works the other way, raising the quantity above equilibrium. It pushes the price buyers pay down and the price sellers receive up, and it creates deadweight loss because the marginal cost of the extra units exceeds their marginal benefit. Price ceilings and floors also create deadweight loss by blocking mutually beneficial trades. Tariffs and quotas on imports raise the domestic price, benefit domestic producers, harm domestic consumers and lose total surplus.
When drawing, mark the original equilibrium, the new quantity, the two prices, and shade the areas you name. Compute areas of triangles and rectangles from the labelled numbers. For a numerical tax question, the new quantity is read where the vertical gap between demand and supply equals the tax. The numbers in this lesson are invented for practice. If a question asks who bears the tax, compare the elasticities rather than who writes the cheque to the government.
Worked example
A tax of 4 per unit cuts quantity from 100 to 80 (invented). Find the tax revenue and the deadweight loss.
Revenue = tax × new quantity = 4 × 80.
Revenue is 320.
Deadweight loss is a triangle: ½ × base (tax 4) × height (lost quantity 20).
Deadweight loss = ½ × 4 × 20 = 40.
Practice problem and solution
A subsidy creates extra units whose marginal cost exceeds their marginal benefit. Does it create deadweight loss? Type yes or no.
Yes. Producing units that cost more than they are worth lowers total surplus.
Mental model: Efficient markets maximise surplus. Taxes and controls lose some of it.
Common trap: Thinking the party that sends the tax payment bears the burden.
4. Production, costs and the short run
Learning goal: Use marginal product and cost curves to find output and explain the shapes of cost curves.
Unit 3 carries 22% to 25% of the multiple-choice section. In the short run at least one input, such as a factory, is fixed. Adding workers raises output, but diminishing marginal returns eventually set in: each added worker adds less than the previous one, because the workers share the fixed equipment. Marginal product is the change in output from one more worker. Total product rises quickly at first and then flattens.
Costs mirror production. Total cost is fixed cost plus variable cost. Marginal cost, MC, is the change in total cost from producing one more unit and eventually rises because of diminishing returns. Average total cost, ATC, is total cost per unit and equals average fixed cost plus average variable cost. MC crosses both ATC and AVC at their minimum points: when marginal cost is below the average, it pulls the average down, and when above, it pushes it up.
Average fixed cost always falls as output rises because the fixed cost is spread over more units. So ATC falls at first, reaches a minimum and then rises as the rising AVC dominates. To find costs from a table, compute the changes: MC = ΔTC / ΔQ, ATC = TC / Q, AVC = VC / Q. The numbers in this lesson are invented for practice. Always check the units and make sure each column answers the question being asked.
In the long run all inputs are variable. Economies of scale mean long-run average cost falls as the firm grows, perhaps through specialisation; diseconomies of scale mean it rises, perhaps because of management complexity; constant returns means it stays flat. The shutdown decision is a short-run one: shut down when price is below minimum AVC, because revenue would not even cover the variable cost. Fixed costs are paid in either case, so they do not enter the decision.
Worked example
At Q = 10 total cost is 200 and at Q = 11 total cost is 215 (invented). Find marginal cost, and ATC at Q = 11.
MC = ΔTC / ΔQ = (215 − 200) / 1.
MC = 15.
ATC at Q = 11 is 215 / 11.
ATC ≈ 19.5. Because MC (15) is below ATC, ATC is falling here.
Practice problem and solution
A firm has total cost of 500 for 25 units. What is its average total cost?
500/25 = 20.
Mental model: Diminishing returns make MC rise. MC crosses ATC and AVC at their minimums.
Common trap: Including fixed costs in the shutdown rule.
5. Perfect competition
Learning goal: Find the profit-maximising output and describe short-run and long-run outcomes for price takers.
A perfectly competitive market has many small sellers, identical products, free entry and exit and full information. Each firm is a price taker: it can sell as much as it wants at the market price but nothing above it. For a price taker, marginal revenue equals the price, so the firm's demand curve is horizontal at the market price. The firm chooses output by comparing price with cost, and the market sets the price.
Profit is maximised where marginal revenue equals marginal cost, provided price covers average variable cost. If P is above ATC at that quantity the firm earns an economic profit equal to (P − ATC) × Q. If P is below ATC but above AVC, the firm takes a loss but keeps producing in the short run, since revenue covers variable cost and part of fixed cost. If P is below AVC the firm shuts down. The firm's short-run supply curve is the part of the MC curve above minimum AVC.
Free entry and exit drive the long run. Economic profits attract new firms, supply shifts right and the price falls until economic profit is zero. Losses cause exit, supply shifts left and the price rises. In long-run equilibrium, P = MC = minimum ATC. That means productive efficiency, producing at the lowest cost, and allocative efficiency, producing where price equals marginal cost, which equals the marginal benefit to consumers.
On the exam, draw two side-by-side graphs: the market on the left, the firm on the right. A change in market demand shifts the market curve, and the firm graph then shows a new horizontal price line. Compare before and after for the firm's output and profit. A normal economic profit of zero does not mean the firm earns nothing: the owner still earns an accounting return that covers the opportunity cost of her time and capital. The numbers here are invented for practice.
Worked example
Market price is 12 and at the profit-maximising output of 50 units, ATC is 9 (invented). Find the economic profit.
Profit per unit = P − ATC = 12 − 9 = 3.
Total profit = 3 × 50.
Profit = 150.
This positive profit would attract entry in the long run.
Practice problem and solution
A firm sells at P = 8 and its profit-maximising quantity is 30 with ATC of 8. What is its economic profit?
(8 − 8) × 30 = 0.
Mental model: MR = MC for output. Entry drives economic profit to zero.
Common trap: Thinking zero economic profit means the owner earns nothing.
6. Monopoly and monopolistic competition
Learning goal: Analyse market power, pricing and efficiency for firms with downward-sloping demand.
Unit 4 carries 15% to 22% of the multiple-choice section. A monopoly is the only seller of a good with no close substitutes, protected by barriers to entry such as legal protection, control of a key resource or economies of scale. Facing the whole market demand curve, a monopolist must lower the price to sell more units, and the lower price applies to all units. So marginal revenue is below price, and the marginal revenue curve lies below the demand curve.
The monopolist still maximises profit where MR = MC, but then reads the price from the demand curve above that quantity. The result is a higher price and lower quantity than under perfect competition. Profit is (P − ATC) × Q and can persist because barriers block entry. The monopoly outcome has a deadweight loss, since some units where the value to buyers exceeds the marginal cost are not produced. Regulation can push the price toward marginal cost, but this may cause a loss if ATC is above MC.
Price discrimination means charging different customers different prices for the same good based on willingness to pay. It requires market power, the ability to separate customers and no easy resale. Perfect price discrimination captures all consumer surplus and removes the deadweight loss, though it moves surplus to the seller. Student discounts and airline fares are everyday examples.
Monopolistic competition has many firms selling differentiated products with free entry. Each has some market power, so its demand slopes down, and it maximises profit where MR = MC. In the long run entry shifts each firm's demand left until price equals ATC and economic profit is zero, but at a point where ATC is above its minimum and P is above MC. The result is excess capacity and some inefficiency, offset by variety. Advertising and branding are ways of differentiating, and the numbers in this lesson are invented.
Worked example
A monopolist produces 20 units where MR = MC, and the demand curve gives a price of 15; ATC is 11 (invented). Find profit.
Price per unit is 15 and ATC is 11.
Profit per unit is 4.
Total profit = 4 × 20.
Profit = 80, which can persist because of barriers.
Practice problem and solution
At the quantity where MR = MC, does a monopolist's price equal or exceed marginal cost? Type exceed or equal.
Price exceeds marginal cost, since price is read from the demand curve above the MR = MC quantity.
Common trap: Reading the price from the MR curve instead of demand.
7. Oligopoly and game theory
Learning goal: Use payoff matrices to find dominant strategies and Nash equilibria and explain collusion.
An oligopoly has a few large firms whose decisions depend on each other. Barriers to entry are significant and products may be identical or differentiated. Because each firm's profit depends on rivals' choices, economists use game theory. A payoff matrix lists each firm's profit for every combination of strategies.
A dominant strategy is the best choice whatever the rival does. A Nash equilibrium is a pair of strategies where neither firm can gain by changing its own choice while the other stays put. A game may have a dominant strategy equilibrium, or a Nash equilibrium without dominant strategies, or more than one equilibrium. To find one, check each firm's best response to each rival choice and mark where the best responses meet.
The prisoner's dilemma shows why firms struggle to collude. Both would earn more if they cooperated, say by keeping prices high, but each has a private incentive to cheat. If cheating is a dominant strategy, the equilibrium is both cheating, which leaves them worse off than cooperating. Repeated interaction and the threat of punishment can sustain cooperation, but formal price-fixing agreements are illegal in many countries. A cartel is a group of firms that coordinate to restrict output and raise prices.
When reading a payoff matrix, keep the order of payoffs straight: the first number belongs to the row player and the second to the column player. Underline the best response in each column for the row player and in each row for the column player. A cell with both underlined is a Nash equilibrium. The payoffs here are invented. On a free-response question, name the strategy, state why it is dominant or not, and say what outcome results.
Worked example
Firms A and B choose High or Low price. Payoffs (A, B): High/High 10,10; High/Low 2,14; Low/High 14,2; Low/Low 6,6 (invented). Find the Nash equilibrium.
If B plays High, A gets 10 from High and 14 from Low, so A prefers Low.
If B plays Low, A gets 2 from High and 6 from Low, so A prefers Low.
By symmetry B prefers Low whatever A does.
Low/Low (6,6) is the Nash equilibrium, although High/High pays more.
Practice problem and solution
In the example, what is A's payoff at the Low/Low equilibrium?
Low/Low gives (6,6), so A's payoff is 6.
Mental model: Find best responses. Nash equilibrium is where they meet.
Common trap: Assuming the equilibrium is the outcome with the highest joint payoff.
8. Factor markets: labour and resources
Learning goal: Derive demand for labour from marginal revenue product and find the hiring rule.
Unit 5 carries 10% to 13% of the multiple-choice section. Firms demand labour and other inputs because of what they can produce, so factor demand is a derived demand. The marginal revenue product of labour, MRP, is the extra revenue from hiring one more worker: marginal product times marginal revenue. In a competitive product market MR equals price, so MRP equals marginal product times price. Because marginal product eventually falls, MRP slopes down, and it is the firm's demand curve for labour.
The hiring rule is to hire workers until MRP equals the marginal factor cost, MFC. In a competitive labour market the firm takes the wage as given, so MFC equals the wage. The firm hires up to the point where MRP equals the wage: a worker who adds more revenue than the wage is worth hiring, and one who adds less is not. The same rule applies to capital, with the price of capital as the factor cost. To use more than one input at the lowest cost, equalise MP per dollar across inputs.
Labour demand shifts when product price, productivity or the price of other inputs changes. A higher product price raises MRP and shifts labour demand right. Better technology that raises marginal product does the same. Labour supply shifts with population, preferences for leisure and wages in other jobs. The equilibrium wage is where market labour demand meets market labour supply.
A monopsony is a single buyer of labour. To hire more it must raise the wage for all workers, so marginal factor cost lies above the supply curve. It hires where MRP = MFC and then pays the wage read from the supply curve, which is below MRP. Compared with a competitive market, a monopsony hires fewer workers at a lower wage. A minimum wage set between the monopsony wage and the competitive wage can raise both wages and employment in this special case. The numbers here are invented for practice.
Worked example
A worker adds 5 units of output, each sold at 8 (invented). The wage is 30. Should the firm hire?
MRP = 5 × 8 = 40.
MFC is the wage, 30.
MRP exceeds the wage.
Hire the worker, and check the next one in the same way.
Practice problem and solution
A worker's marginal product is 6 and the product price is 5. What is MRP?
MRP = MP × price = 6 × 5 = 30.
Mental model: Hire until MRP equals MFC. Monopsony pays below MRP.
Common trap: Treating a wage change as a shift in labour demand.
9. Market failure: externalities and public goods
Learning goal: Identify externalities and public goods and judge policies that fix them.
Unit 6 carries 8% to 13% of the multiple-choice section. A market fails when it does not allocate resources efficiently. An externality is a cost or benefit that falls on people who are not part of the transaction. With a negative externality, such as pollution, the social cost exceeds the private cost, so the market produces too much. With a positive externality, such as vaccination, the social benefit exceeds the private benefit, so the market produces too little.
On a graph, a negative externality puts the marginal social cost curve above the marginal private cost curve. The efficient quantity is where marginal social benefit equals marginal social cost, which is lower than the market quantity. A per-unit tax equal to the marginal external cost moves the market to the efficient quantity. For a positive externality, a per-unit subsidy equal to the marginal external benefit does the same. Tradable permits and regulations are other options.
Public goods are non-excludable and non-rival: people cannot be kept from using them, and one person's use does not reduce another's. National defence is the standard example. Because people can free-ride, private firms will not supply enough, so governments provide them. Common resources are non-excludable but rival, such as open fisheries, and tend to be overused, the tragedy of the commons. Private goods are excludable and rival, and club goods are excludable and non-rival.
The Coase idea says that if property rights are clear and bargaining costs are low, parties can negotiate to an efficient outcome without government. In practice, bargaining costs are high when many people are affected. Government policy has costs too, such as information problems. On an exam, identify whether the externality is positive or negative, say which curve is wrong, state the efficient quantity and name one policy tool with its effect. The numbers in this lesson are invented for practice.
Worked example
A good's marginal external cost is 3 per unit (invented). What per-unit tax moves the market to the efficient quantity?
The efficient quantity needs the price to reflect the social cost.
The gap between social and private cost is the external cost, 3.
A tax of 3 per unit closes the gap.
The market quantity falls to where MSB equals MSC.
Practice problem and solution
Is a positive externality associated with overproduction or underproduction by the market? Type under or over.
Underproduction: the social benefit exceeds the private benefit.
Mental model: Fix externalities with taxes or subsidies. Public goods need collective provision.
Common trap: Treating a positive externality as overproduction.
10. Exam day: microeconomics graphs and free response
Learning goal: Use the exam format and graph habits to score on the free-response questions.
The College Board's AP Microeconomics exam page lists two sections. Section I has 60 multiple-choice questions in 1 hour 10 minutes, worth 66% of the exam score. Section II has three free-response questions in 1 hour including a 10-minute reading period, worth 33%: one long question worth 50% of the section and two short questions worth 25% each. Check the exam page for your year, since format and policies can change.
The free-response section tests assertions about concepts, explanations of models and outcomes, numerical analysis and graphs. Market structure questions, such as a monopolist or a perfectly competitive firm, often ask you to draw a graph, identify a quantity or price, compute profit and then explain what happens when something changes. Practise each of the main graphs from memory: supply and demand with a tax, a firm in perfect competition, a monopolist, and a negative externality.
For a graph, label both axes, label every curve, mark the equilibrium or optimal point with dotted lines to the axes and show shifts with arrows. For a profit question, find the quantity first where MR = MC, then read the price and ATC at that quantity, and draw the profit rectangle. Many mistakes come from reading the price from the MC curve rather than the demand curve for a monopolist, or from using the wrong quantity for ATC.
Write answers that state a direction and a reason. For example: 'The price rises because supply decreases, creating a shortage at the old price.' Avoid describing without concluding. In calculations show the formula, the substitution and the result with units, since process can earn credit even if arithmetic slips. Use the reading period to underline command words such as 'identify', 'calculate' and 'explain', and note the scenario's market structure. If a question says short run, do not mention entry and exit.
Worked example
Explain what happens to the price of a good when an input cost rises.
The input cost rise shifts supply left.
At the old price there is a shortage.
Price rises until quantity demanded equals quantity supplied.
The equilibrium price is higher and quantity is lower.
Practice problem and solution
What percent of the free-response section is the long question worth? Enter a number.
The long question is 50% of the section.
Mental model: Label graphs. Find the quantity first. State direction and reason.
Common trap: Reading a monopolist's price from the cost curve.