AP® Microeconomics review sheet from Aim for Five (aimforfive.com/micro/units/5/5-2)
Unit 5 · Topic 5.2
5.2 Changes in Factor Demand and Factor Supply
Factor demand and factor supply shift for reasons outside the wage itself. Labor demand shifts with demand for the product, worker productivity and the prices of other inputs; labor supply shifts with population, preferences and opportunities elsewhere. Knowing which curve moves lets you predict what happens to wages and employment.
Key terms
- change in factor demand
- change in factor supply
- productivity
- substitute and complementary inputs
- equilibrium wage
- labor supply
Moving along a curve versus shifting it
On a labor-market graph, the wage is on the vertical axis and the quantity of labor (number of workers or hours) is on the horizontal axis. Labor demand slopes down; labor supply slopes up. Where they cross is the equilibrium wage and quantity of labor.
A change in the wage moves you along the curves. Anything else that changes how many workers firms want, or how many people want to work, at every wage shifts a curve. These shifters are what this topic is about.
What shifts the demand for labor
- Demand for the product: since labor demand is derived (5.1), more demand for the product raises its price, which raises MRP. Labor demand shifts right. Less product demand shifts it left.
- Productivity: if workers produce more per hour (better training, better tools, new technology that helps them), MP rises, so MRP rises. Labor demand shifts right.
- The price of a substitute input: a substitute can replace workers, like self-checkout machines for cashiers. If the substitute gets cheaper, firms switch toward it, so labor demand shifts left. (A cheaper input also lowers costs, which can raise output and hiring a little, but on the exam use the substitution reasoning unless a question says otherwise.)
- The price of a complementary input: a complement is used together with workers, like trucks and truck drivers. If the complement gets cheaper, firms use more of it and need more workers to go with it, so labor demand shifts right.
What shifts the supply of labor
- Population and immigration: more working-age people means more labor supplied at every wage (shift right).
- Preferences for work versus leisure: if people choose more free time, labor supply shifts left.
- Pay in other jobs: if wages rise in a different job workers could do, some leave this market, so supply here shifts left.
- Training, education and licensing: if more people gain the skills a job needs, supply of that labor shifts right. A new license requirement shifts it left.
- Non-wage features of the job: better working conditions or benefits attract more workers at each wage (shift right).
Predicting the new equilibrium
When both curves shift at once, one of the two outcomes is certain and the other depends on which shift is bigger. This is the same double-shift logic as in product markets (2.7).
Everything here applies to other factors too. For example, higher demand for farm products raises the demand for farmland, which pushes up land rents.
| Change | Curve that shifts | Equilibrium wage | Equilibrium employment |
|---|---|---|---|
| Labor demand increases | Demand shifts right | Rises | Rises |
| Labor demand decreases | Demand shifts left | Falls | Falls |
| Labor supply increases | Supply shifts right | Falls | Rises |
| Labor supply decreases | Supply shifts left | Rises | Falls |
Worked examples
Try each one yourself first, then open the solution.
- Example 1
A change in product demand
Demand for electric cars rises sharply. Using a correctly labeled graph described in words, explain what happens to the wage and employment of workers in the perfectly competitive market for electric-car battery workers.
Show the solutionHide the solution
- Step 1: Start with the cause: higher demand for electric cars raises their price (and the quantity sold).
- Step 2: A higher product price raises each battery worker's MRP (MP × P), since each worker's output is now worth more.
- Step 3: Graph: wage on the vertical axis, quantity of battery workers on the horizontal axis, a downward-sloping labor demand curve D₁ and an upward-sloping labor supply curve S, crossing at W₁ and L₁.
- Step 4: The demand for labor shifts right to D₂. The new equilibrium, where D₂ crosses S, is at a higher wage W₂ and a larger quantity of labor L₂.
Answer: Labor demand shifts right, so the equilibrium wage and the number of battery workers employed both rise.
- Example 2
Substitute or complement input?
The price of warehouse robots falls. In Warehouse A, robots do the same packing jobs workers used to do. In Warehouse B, each robot needs a technician to run and fix it. What happens to the demand for packers in A and for technicians in B?
Show the solutionHide the solution
- Step 1: In Warehouse A, robots are a substitute for packers: they do the same job. When the substitute gets cheaper, the firm swaps toward robots, so the demand for packers shifts left.
- Step 2: In Warehouse B, robots and technicians are complements: they're used together. Cheaper robots mean the firm buys more robots, and every extra robot needs technicians. The demand for technicians shifts right.
Answer: Demand for packers (substitute) decreases; demand for technicians (complement) increases.
- Example 3
Two shifts at once (classic trap)
In a perfectly competitive market for nurses, a wave of new nursing-school graduates enters the market at the same time as an aging population raises demand for health care. What happens to nurses' equilibrium wage and employment?
Show the solutionHide the solution
- Step 1: More graduates means labor supply shifts right. On its own, that lowers the wage and raises employment.
- Step 2: More demand for health care raises the demand for nurses (derived demand), so labor demand shifts right. On its own, that raises the wage and raises employment.
- Step 3: Both shifts raise employment, so employment definitely rises.
- Step 4: The supply shift pushes the wage down and the demand shift pushes it up. Without knowing which shift is bigger, the change in the wage is indeterminate.
Answer: Employment rises. The effect on the wage is indeterminate (it depends on the relative sizes of the shifts).
Common mistakes
- Shifting the labor demand curve when the wage changes. A wage change is a movement along the curve.
- Shifting labor supply when demand for the product changes. Product demand affects the demand for labor, not the supply.
- Mixing up substitute and complement inputs. A cheaper substitute lowers labor demand; a cheaper complement raises it.
- Claiming a definite wage change when both curves shift. One variable is always indeterminate in a double shift.
On the exam
- Factor-market questions often link to a product market: a change in product demand, or a new technology, shows up as a shift in labor demand. Trace the chain step by step: product price, MRP, labor demand, wage and employment.
- Label the labor-market axes 'Wage' and 'Quantity of labor', not 'Price' and 'Quantity'.
Connected topics
Videos
Check yourself
4 questions on 5.2 Changes in Factor Demand and Factor Supply. Pick an answer to see if you got it, and why.
| Wage (per hour) | Quantity of labor demanded (workers) | Quantity of labor supplied (workers) |
|---|---|---|
| $10 | 900 | 500 |
| $12 | 800 | 600 |
| $14 | 700 | 700 |
| $16 | 600 | 800 |
| $18 | 500 | 900 |
Hypothetical data for the market for delivery drivers in a city, a perfectly competitive labor market
What are the equilibrium wage and employment in this market?
At a wage of $12 per hour, which of the following is true?
Suppose online shopping grows and the demand for delivery drivers rises by 200 workers at every wage. What are the new equilibrium wage and employment?
New software lets each accountant at a firm finish more tax returns per day. If the price the firm charges for a tax return doesn't change, the firm's demand for accountants will
0 of 4 answered