Households Buy Less of the Product
Consumers stop buying the good these workers make, so the output price falls, marginal revenue product falls with it, and labor demand shifts left.
Households Buy Less of the Product
Labor MarketConsumers stop buying the good these workers make, so the output price falls, marginal revenue product falls with it, and labor demand shifts left.
Equilibrium at Quantity of Labor 50, Wage ($/hr) 15
Start in Equilibrium
The competitive labor market begins in equilibrium where labor demand (DL = MRP) crosses labor supply (SL). The wage and the quantity of workers hired are set at that intersection.
Now try it yourself: shift the curves in a graded FRQ drill, or open this graph in the free sandbox.
Households Buy Less of the Product, step by step
- 1
Start in Equilibrium
The competitive labor market begins in equilibrium where labor demand (DL = MRP) crosses labor supply (SL). The wage and the quantity of workers hired are set at that intersection.
- 2
Consumers Turn Away From the Good
Tastes shift and households buy far less of the product these workers assemble. This shock lands in the output market. Nothing about the workers themselves has changed: they are just as skilled, and the machinery beside them costs exactly what it did yesterday.
- 3
Output Price Falls, So Does MRP
Weaker product demand pushes the output price down. Marginal revenue product equals marginal product times the output price, so every worker's marginal revenue product falls even though each one still produces the same physical quantity of output per hour. This is what economists mean by calling labor demand a derived demand.
- 4
Labor Demand Shifts Left
Because labor demand is the marginal revenue product curve, the lower output price drags that whole curve leftward. At any wage firms now want fewer workers than before.
- 5
New Equilibrium: Lower Wage and Employment
Labor supply is unchanged, so the market slides down along it to the new intersection. The equilibrium wage is lower and fewer workers are employed. Trouble in the product market passes straight through to the people who make the product.
Where it ends up
Labor demand is derived from the output market, so weaker demand for the product lowers its price and the marginal revenue product of labor, shifting labor demand left and pulling down both the wage and employment.
Now draw it yourself
Same graph, graded on whether you move the right curve and leave the rest alone.
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