There’s one expression of this idea I like because it uses the partial equilibrium supply & demand model that introductory microeconomics classes always use, and it’s a reasonably easy formulation to follow if one knows that model. (It also illustrates a danger of doing back-of-a-napkin partial equilibrium analysis for a single market when that market’s big enough to have a big knock-on effect on another market.)
I’m lifting this from Robin Hahnel (Journal of Economic Issues, 41(4), pp. 1139-1159), although he says he got it from Axel Leijonhufvud:
Consider a labor market and a goods market. Assume that if either market is out of equilibrium the excess supply or excess demand in that market will eventually lead to wage or price adjustments leading that market to its equilibrium. Now assume that while the goods market is initially in equilibrium, the labor market is not because the wage rate is temporarily higher than the equilibrium wage. While the excess supply in the labor market will generate equilibrating forces pushing the wage rate down toward its equilibrium, suppose it does not reach its equilibrium immediately, and in the meantime labor contracts are struck at a wage rate that is still higher than the equilibrium wage. If the labor demand curve is elastic this will result in lower labor income than would have been the case if the wage rate had reached its equilibrium. But the demand curve in the goods market was premised on the (implicit) assumption that the labor market was in equilibrium, and therefore that labor income was higher than it actually will be. When we reconstruct the demand curve in the goods market based on the actual outcome in the labor market, where labor income is lower than it would have been had the labor market been in equilibrium, we get an actual goods demand curve to the left of the one anticipated. No matter how quickly or slowly the price in the goods market adjusts to the resulting excess supply, we will get a drop in sales and revenues in the goods market.
But lower sales and revenues in the goods market will decrease the demand for labor in the labor market. The demand curve we originally drew in the labor market was premised on the (implicit) assumption that we had reached the equilibrium outcome in the goods market. Now that sales and revenues are lower in the goods market, when we reconstruct the demand for labor curve based on the new, actual outcome in the goods market, we get a new demand for labor curve to the left of the initial one. No matter how quickly or slowly the wage rate adjusts to the new excess supply, employment and labor income will drop, further depressing the actual demand for goods in the goods market. Instead of remaining in equilibrium in the goods market and moving toward the higher, equilibrium level of employment in the labor market, we move out of equilibrium in the goods market and even farther away from equilibrium levels of employment in the labor market.
There’s one expression of this idea I like because it uses the partial equilibrium supply & demand model that introductory microeconomics classes always use, and it’s a reasonably easy formulation to follow if one knows that model. (It also illustrates a danger of doing back-of-a-napkin partial equilibrium analysis for a single market when that market’s big enough to have a big knock-on effect on another market.)
I’m lifting this from Robin Hahnel (Journal of Economic Issues, 41(4), pp. 1139-1159), although he says he got it from Axel Leijonhufvud: