David K.H. Begg, Gianluigi Vernasca-Economics-McGraw Hill Higher Education (2011)

CHAPTER 10 The labour market
T_he_s_up_p_ l y_of_ l o_b_ou_r -
We now discuss the supply of labour, for the individual, the industry and the whole of the economy. We
can then combine labour demand and labour supply to determine the equilibrium level of wages and
employment.
The labour force is all
individuals in work or looking
for work.
Individual labour supply: hours of work
We analyse labour supply in two stages: how many hours people work once in the
labour force and whether people join the labour force at all.
Once in the labour force, how many hours will a person wish to work? This depends on the real wage, W/P,
the nominal wage divided by the price of goods, which shows the quantity of goods that labour effort will
purchase. It is the real wage that affects labour supply decisions.
Figure 10.4 shows two possible labour supply curves, relating hours of work supplied to the real wage. The
curve SS1 slopes up. Higher real wages make people want to work more. The labour supply curve SS2 is
backward-bending. Beyond A, further real wage rises make people want to work fewer hours.
The alternative to working another hour is staying at home and having fun. Each of us has 24 hours a day
to divide between work and leisure. More leisure is nice but by working longer we can get more real
income with which to buy consumer goods. How should an individual trade off leisure against consumer
goods in deciding how much to work?
This is an application of the model of consumer choice in Chapter 5. The choice is now between goods as
a whole and leisure. An individual will want to work until the marginal utility derived from the goods that
an extra hour of work will provide is just equal to the marginal
utility from the last hour of leisure.
Hours of work supplied
The labour supply curve 551 slopes up and more
hours of work ore supplied as the real wage
increases. But the labour supply curve might bend
back. Along 552 higher real wages reduce labour
supply once we reach the point A.
figure 10.4
Individual labour supply
A higher real wage increases the quantity of goods an extra
hour of work will purchase. This makes working more
attractive than before and tends to increase the supply of
hours worked. But there is a second effect. Suppose you work
to get a target bundle of goods. You work to get enough to be
able to eat, pay the rent, run a car and have a holiday. With a
higher real wage you need to work fewer hours to earn the
same target bundle of goods.
These two effects are precisely the substitution and income
effects introduced in the consumer choice model of Chapter 5.
An increase in the real wage increases the relative return on
working. It leads to a substitution effect or pure relative price
effect that makes people want to work more. But a higher real
wage also tends to raise people's real income. This has a pure
income effect. Since leisure is probably a luxury good, the
quantity of leisure demanded increases sharply when real
incomes increase. This income effect tends to make people
work less. The overall effect of a real wage rise, and the shape
of the supply curve for hours worked, depends on which effect
is larger.
To decide whether or not the substitution effect will dominate
the income effect, we must look at actual data on what people
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