It was a penalty because it was given as so, but contact does not mean a penalty should be given. It was very soft and if the ref hadn't given it I think VAR wouldn't have overturned it.
The better team did win though. Im not sure it's down to them not working hard enough though, more as you said the system isn't working and the players looking like they have no confidence at all.
Like you, I do fear for us against Man City though as we look all over the place at the back. A back 4 of Milner, Matip, VVD and Tsimikas (probably the only player in a bit of form at the mo) does not instill confidence against Haaland at the moment.