Answer to Question #130566 in Microeconomics for Kutlwano

Question

Use a graph to illustrate and explain the individual supply of labour curve. In your answer, describe the forces that determine the shape of the individual supply of labour curve

Answer 1

The individual supply of labour is regressive at the upper part; it is backward bending. 

The main reason is that a worker's time is assumed to have two competing uses: being spend doing paid work, and being spend on leisure (non-paid time). Now, because time is a scarce resource, work and leisure become substitutes; a labour-leisure trade off exists. A worker must decide on either allocating more of his time towards work or allocating more towards leisure. 

The regressive nature of the individual supply curve for labour is therefore affected by the substitution effect and the income effect between work and leisure. When a worker's income is low, the marginal utility of income will be high as the worker will be struggling satisfying daily expenditures. An increase in wages will therefore makes work more attractive than leisure, and therefore more time is devoted towards work and less towards leisure. This implies that the the substitution effect of a wage increase exceeds the income effect. The labour supply, in terms of hours commited towards work, is therefore upward sloping. 

At high incomes, the marginal utility of income becomes poor since the worker is likely to be close to his/her target income. An increase in wages reduces the marginal utility of income further as the worker achieves a target income. The income effect will thus exceeds the substitution effect and more time is devoted towards leisure and less towards work; the individual labour supply curve bends inwards. This is illustrated by the graph below.

On the graph above, the individual labour supply curve is labbled SS. As shown on the graph, when the wage rate is low, below W*, the worker increases the number of hours devoted towards work for every increase in wages. The reason being that at lower income levels the substitution effect exceeds the income effect. A higher wage than the previous one makes work more attractive; the worker is incentiviced and become more willing to trade more hours towards work. Leisure is thus traded off with more work as the marginal utility of income exceeds that of leisure. This will take place until a certain wage rate, W* on the diagram. Beyond W*, the wage rate is now high and the worker has a high income. The principle of diminishing marginal utility will help to explain that at this point, the marginal utility of leisure is now higher than that of income and hence the income effect now exceeds the substitution effect. With each additional wage increase, the marginal utility of income falls further as that of leisure increases. The worker will then reduce hours spend at work and enjoy more leisure (non-paid time).

Leisure is considered a normal good and hence the quantity of leisure consumed is expected to increase as income increases. On the other hand, work is considered unpleasant and hence motivated only by money however, it is also inferior and hence expected to fall as income rises.

In deriving the individual labour supply curve, the following assumptions are made:

• Unpaid leisure is a normal good,

•Workers are rational beings, and they seek to maximize utility,

•Work provides disutility and hence is compensated by wages,

• Workers choose when to work, and how many hours to commit towards work, that is, there are no contractual obligations at work.