How changes in supply and demand affect income

0:00- [Instructor] So one of the things that impacts a lot of us because we work for a living, is how supply and demand, either at a smaller micro level or at an aggregate level might impact wages. So let's just explore the concept a little bit. So we could think about it just in terms of the market for labor and there it might be a little bit more obvious.

0:23So if this axis is the price of labor, which is essentially wages, and this right over here is the quantity of labor. So this is quantity. We can draw a demand curve at a high price. There will be low quantity of labor demanded, and that at a low price, people would want more and more labor.

0:47So that is the demand for labor. And then the supply for labor at a low wage or low price, not a lot of people are going to wanna work for that low wage, but as that wage goes up, more and more people would wanna work for it. So that would be supply. And we know in any market like this, there is an equilibrium price and we have an equilibrium quantity.

1:11So we could do P star if we want for the equilibrium price, and you could do Q star for that equilibrium quantity. Now if all of a sudden there were a lot more people in this labor market and we could think about a labor market for a specific skill, if we want to get really particular, we could think about the labor market as a whole.

1:29But if we think about more people entering for a specific skill, if the supply were to increase, so you would see that graph or that line, that supply shift to the right, well, it's what we would imagine. The prices or the wages would now go down. There's more people to compete for that job.

1:49And likewise, if for some reason people were to leave that profession, go do something else, then the wages are going to go up because now the employers are really struggling to find people and they're going to keep raising the wages until they can find enough people to do it.

2:05Now, on the other hand, we can think about demand. If for whatever reason, demand for that particular job goes down, you could imagine what will happen. So this would shift demand to the left. So demand goes here and now our new equilibrium price of labor, which in this case is a wage, will go down.

2:25And of course if demand goes up, the prices would go up. More people want that skill. But we could also think about it at an aggregate level. And there it gets a little bit more complicated. So if we say that this is aggregate, aggregate demand, so it's adding up all the demand for goods and services in the economy, this is aggregate, aggregate, aggregate supply.

2:52And now this is just the general level of price in the economy now, and now this quantity, you could even think about this as something like real GDP 'cause it's total aggregate quantity or output of the economy here. Well, demand might still have a similar dynamic.

3:11If demand were to go up, let's imagine there, demand goes there, we see equilibrium prices goes up, especially if supply doesn't change or doesn't shift at all. And so you would have, you would be experiencing some inflation. And in that inflation it might be the cost of all goods and services are going up.

3:31And obviously in a real economy, some things will go up more than others. But you could imagine that that will increase wages too 'cause wages are an important input into what is being produced, so the prices of everything go up, that could lead to wages going up.

3:48Obviously inflation also has a bit of a cycle to it as the price of everything goes up, then people demand higher wages. So they can have a reasonable standard of living. And of course if demand were to shift the other way, if demand were to go down, then there's probably excess capacity in the system.

4:07And the prices of things will go down, including the price of things like labor, inputs into production, the price in general of inputs into production, including labor could go down. Now, supply is a more complicated picture because there could be different reasons why supply goes up or down.

4:25So let's imagine supply going up. So, and we're talking about aggregate supply in this situation. So this is our new aggregate supply. So there's a world where aggregate supply goes up, maybe it's a service and it's just a lot more people who can do that job come into it.

4:40And then it becomes very similar to this being the market for labor, in which case you'd see prices go down. And if it's because there's a lot more people who can do that job, it's probably that their wages go down. But if that supply went up, maybe due to something like productivity, productivity, and not only did the prices of that, or in aggregate, I guess we're talking about, the aggregate prices have gone down and the aggregate quantity has gone up, we're able to produce more and we're doing it and we're able to clear it or sell it, or the market prices are lower.

5:17It doesn't necessarily mean that wages have gone down. In fact, if anything, firms might be more profitable in this and the cost of labor per unit that is being produced actually goes down. So they could actually afford to pay workers more. Now on the other hand, productivity might be directly replacing what workers were doing before, and so it could create a surplus of labor.

5:43So this could go either way. It could make wages go up or it could make wages go down. So this is all I know, it's sometimes very convenient to try to draw and hope to get a really clear mathematical answer. But when we're talking about the economy as a whole, it depends what's really going on.

6:05Generally speaking, if there's a lot of folks chasing a few jobs, well then, wages might go down. If there's a lot of jobs chasing a few folks, then wages will go up.