Under what conditions is it likely that the labor supply curve may become backward bending? What roles do the income and substitution effects play?

Question

What will be an ideal response?

Answer 1

The labor supply curve is based on the willingness of persons to work at different pay rates. The two major effects that affect this are the income effect and the substitution effect. The income effect for higher wages is to make consumers richer; the expected effect of this is to increase demand for leisure and decrease the willingness to work. The substitution effect of higher wages makes work more attractive than (unpaid) leisure, with the expected effect that willingness to work would increase.These two effects are of opposite significance. Most economists think that for low-wage workers, the substitution effect is stronger and that for high-income workers, the income effect is about equal in size to the substitution effect. Therefore, a wage increase for high-income workers is not likely to increase significantly the quantity of labor offered in the market. If the income effect is larger in magnitude than the substitution effect, then the labor supply curve will bend backward at high rates of pay so that high pay leads to a lower quantity of labor supplied.As wages rise, people want to take more leisure and to work less (the income effect). At a high enough wage, it is possible for this income effect to outweigh the tendency for higher wages to increase labor supply (the substitution effect).