ChainWhat it assumes · how to break it
Start
Demand for a product falls, for example demand for coal or for high-street retail falls as consumers switch to alternatives.
1
As a result, firms sell less, and the price and marginal revenue of each extra unit fall.
marginal revenue
marginal revenue
Assumes: Firms cannot find new markets for the product.
But: Firms may switch sales to export markets or new products, keeping revenue up.
2
This means the marginal revenue product of labour (MRP = MPP × MR) falls, so the demand curve for labour shifts left, because labour is a derived demand.
derived demand · MRP
derived demand · MRP
Assumes: Output per worker does not change.
But: If firms reorganise to raise output per worker, MPP rises and offsets part of the fall in MR.
3
Consequently, at the old wage there is an excess supply of labour in the industry, so the wage falls to a new, lower equilibrium.
wage determination · excess supply of labour
wage determination · excess supply of labour
Best link to attack
Assumes: Wages are flexible downwards.
Assumes: Wages are flexible downwards.
But: Nominal wages are sticky: contracts, union agreements and the minimum wage stop pay falling, so firms cut jobs and the wage barely moves.
4
Therefore, the wage falls most where labour supply to the industry is inelastic, because workers have industry-specific skills and cannot easily move to other jobs.
elasticity of supply of labour · occupational immobility
elasticity of supply of labour · occupational immobility
Assumes: Workers cannot easily move to other occupations.
But: Workers with general skills move to other sectors, so labour supply to the industry falls and the wage holds up while employment falls instead.
End
Wages in the industry fall, by most where workers are occupationally immobile and pay is flexible.
Evaluation chain
- E1However, the fall in wages depends on how flexible pay is downwards.
- E2Because most workers resist cuts in nominal pay and many low-paid workers are already on the minimum wage, firms rarely cut pay rates.
- E3As a result, firms adjust by freezing pay, so real wages fall slowly through inflation, or by cutting jobs and hours.
- E4So a fall in product demand usually shows up more in employment and hours than in the wage rate, unless inflation erodes real wages.
Another way to attack it: Even if nominal pay is not cut, a pay freeze during inflation cuts real wages, so workers in declining industries fall behind others over time.
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Questions this answers
- Using a diagram, explain how a fall in demand for a product affects wages in that industry.
- Assess the factors that determine wages in an occupation.
- Explain why wages fall faster in some declining industries than in others.
Diagram
Labour market supply and demand: demand (MRP) shifts left from D1 to D2, the wage falls from W1 to W2 and employment from Q1 to Q2. An inelastic (steep) supply curve gives a larger fall in the wage and a smaller fall in employment.
Reverse and related
Rise in demand for the product → demand for labour shifts right, raising wages most where labour supply is inelastic.