MacroeconomicsI_working_version (1)

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Chapter 8
S
Real wage
Labour Supply
Figure 8.2 Dominating substitution effect. The figure shows the situation when households’ reaction to a
rise in wages is an increase in labour supply. With rising wages, households reduce their leisure time and
increase their time spent in work – the net effect is positive – the substitution effect overweighs.
The determinants of labour supply vary across individuals in a real economy. The decision
process about how much to work is determined by individual’s preferences, family
situation, age, education, etc. Considering the time horizon, we can generally state, that in
the short run, the reaction to changes in real wage is not widely obvious. The income effect
with decreasing supply of labour is supposed to dominate in the long run.
8.1.2. Individual vs. Aggregate Labour Supply Curve
The rationale for the shape of individual labour curve seems to be clear and strongly logic.
Let’s examine the circumstances of supplying labour in more details and compare it to
aggregate supply of labour.
In many cases, the individual workers cannot change the number of hours in work
according to the actual wage rate. The labour contracts often specify exactly the standard
working time and other related things. The workers can only decide whether to work or not
(take it or leave it). In some cases, the wage rates intend the workers not to work at all.
That’s why the small increases in wages might not motivate individuals to take up jobs
whereas the large increase might. The aggregate labour supply, consisting of many
individual decisions, is measured in man-hours, which is the total number of hours supplied
by all workers during given period. With rising wage, some new additional households,
which decided not to work, can now decide to take up jobs. Accordingly, the aggregate
labour supply rises in spite of the fact that those, who had already had their jobs before the
wage increased, couldn’t adjust the number of working hours. The slope of the aggregate
labour supply curve is, thus, flatter comparing to individual labour curve as is described in
Figure 8.3.