Backward bending supply curve of labour

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

In economics, a backward-bending supply curve of labour or backward-bending labour supply curve is a graphical device showing a situation in which, as wages increase beyond a certain level, people will substitute leisure for working and thus higher wages lead to less labor being offered.

Term labor-leisure tradeoff Definition: The perpetual tradeoff faced by human beings between the amount of time spent engaged in wage-paying productive work and satisfaction-generating leisure activities. The key to this tradeoff is a comparison between the wage received from working and the amount of satisfaction generated from leisure. Such a comparison generally means that a higher wage entices people to spend more time working, which entails a positively sloped labor supply curve. However, the backward-bending labor supply curve results when a higher wage actually entices people to work less and to "consume" more leisure time.

Overview

As wages increase, there are two considerations affecting a worker's choice of how many hours to work per unit of time (usually day, week, or month). The first is the substitution effect, which says here that the trade-off between working an additional hour and taking one extra hour of leisure has changed in favour of working, resulting in a reason to work more hours at the higher wage than at the lower one. The second and countervailing effect is that the hours worked at the old wage rate now all gain more income than before, creating an income effect that encourages more leisure to be chosen because it is more affordable.

Referring to the graph, if real wages were to increase from W1 to W2 then the worker's substitution effect outweighs their income effect; therefore, they would be willing to increase their hours worked from L1 to L2. However, if the real wage increased from W2 to W3, then the number of hours worked in the situation depicted graphically would fall from L2 to L3. This is because the income effect has now become greater than the substitution effect: the utility to be gained from an extra hour of leisure is now greater than the utility to be gained from the extra income that could be earned by working the extra hour.

The above only examines the effect of changing wage rates on workers already subject to those rates—that is, only an individual's labour supply curve was considered. It did not consider the additional labour supplied by workers previously in other sectors, who are now more attracted to the jobs in this sector. Thus the wage at which the market labour supply curve bends backward may be higher than the wage at which a given worker's curve bends back.

Assumptions

• Workers choose their hours.
• There are no contractual obligations.
• Workers are utility maximising agents.

Caveats

Higher pay for overtime hours can reduce or negate the effect of a backward bending labour supply curve, by increasing wages only for hours worked beyond a certain amount. Overtime maintains the substitution effect at high labour supply, but the income effect from wages increasing on all previous hours worked is eliminated. Thus higher hourly overtime pay can cause workers to work more hours than they would if the higher rate was paid on all hours.

Inverted S shaped supply curve

At very low wage levels the supply curve may also be curved backwards, creating an "inverted s" shape. In this case, further lowering wages will have the effect of increasing the supply of labor. This is explained by the fact that families have some minimum level of income needed to meet their subsistence expenditure requirement.