Factor Markets

What this graph shows

This sandbox is a competitive labor market, the most common factor market on the AP exam. Labor demand (blue, DL) is the firm's marginal revenue product (MRP), the extra revenue each additional worker generates, which slopes down because of diminishing marginal returns. Labor supply (red, SL) slopes up because higher wages draw more workers into the market. Where the two curves cross sets the equilibrium wage and quantity of labor hired.

The key idea is that labor is a derived demand: firms hire workers not for their own sake but for the output and revenue those workers produce, so anything that raises worker productivity or product price shifts MRP and therefore labor demand. You can shift either curve to model events like a productivity boom, a new tax, immigration, or a change in the number of available workers, and read the new wage and employment level instantly.

How to read it

The wage per hour is on the vertical axis and the quantity of labor on the horizontal. The equilibrium wage and employment are set where labor demand (MRP) meets labor supply. Turn on the Wage Level tool to place a horizontal line at a wage you choose: the blue dot shows how much labor firms want to hire and the red dot how many people want to work. Above equilibrium you get a labor surplus (unemployment); below it a labor shortage, and the purple bracket measures the gap.

Three things to try

1. Shift labor demand right (DL) to simulate a jump in worker productivity or product price, and confirm both the equilibrium wage and employment rise together.
2. Shift labor supply right (SL) to model immigration or more people entering the workforce, and notice the wage falls while employment rises, showing the tradeoff a bigger labor pool creates.
3. Turn on the Wage Level tool and drag it above the equilibrium wage to create a labor surplus, reading off the purple bracket how many more workers want jobs than firms will hire, which is the graph's version of a minimum wage.

Common questions