Principles of Economics/Labor Supply

Fig - 1. The backward-bending labor supply curve.

This supply curve shows how the change in real wage rates affects the number of hours worked by employees.

Referring to the graph, if real wages were to increase from W1 to W2 then the worker will obtain a greater utility, due to their higher income. Therefore, they would be willing to increase their hours worked from L1 to L2. Note that this may be hours worked per day, month, year or even lifetime. Over this section of the curve the substitution effect is positive while the income effect is negative. However, the substitution effect is greater than the income effect. Therefore, the increase in the real wage rate will cause an increase in the number of hours worked.

However, if the real wage increased from W2 to W3, then the number of hours worked per year would fall from L2 to L3. This is because the income effect has now become greater than the substitution effect. This is because utility gained from an extra hour of leisure is greater than the utility gained from the income earned working. Beyond this point, workers have reduced incentives to work because they are already being paid enough to sustain their current lifestyle without having to work more hours, therefore creating the backwards bend in the curve.