Some workers may respond to a rise in their hourly pay by choosing to work more hours, whilst others may

choose to work the same or even fewer hours. Use income and substitution effects to explain why this is the case. Wages are the reward to the factor of production labour. An equilibrium wage is obtained through the interaction of the market demand for and market supply of labour. Normally the market supply curve of labour is upward sloping meaning that more people are willing and able to work with increases in the wage rate. However, an individual supply of labour curve differs from the market supply of labour curve. The individual supply of labour curve plots the number of hours an individual is willing and able to work against wage rate. The indivual supply of labour curve is backward bending as illustrated below. T Wage rate S

W2

W1

H2

H1

Hrs worked

The above individual supply curve shows that at low wage rate, individuals are willing to work more when wage rate increases whereas at high wage they may work the same or even reduce hours worked. The shape of the supply curve can be explained using the income and substitution effect. The main assumption is that work is regarded as an inferior by the worker. The worker has to choose between leisure and work. The opportunity cost of leisure will be the wage rate forgone by not working. The substitution effect suggests that when wage rate increase, an individual will supply more hours of work. He will forego leisure hours and replace them by working hours. This is because now the opportunity cost of leisure has increased following the rise in wage rate. Every hour not worked will represent a larger lost in income. Thus, the substitution effect always causes a rise in working hours when wage rises.

On the other hand, a rise in wage rate means a rise in real income and a higher standard of living. Since work is regarded as an inferior good, the rise in real income will result in a fall in hours worked. This is known as the income effect. It can be seen that the income effect opposes the substitution effect. Which effect will be greater will depend on the preferences and priorities of the worker. At low wage rates, workers will respond to an increase in wage rate by supplying more hours of work. The substitution effect will outweigh the income effect. This is because the higher wage will result in a higher living standard for them. However, at high wage rates, an increase in wage will result in a fall in hours worked or no change at all. The income effect more than offset the substitution effect. Workers in the higher income brackets may be satisfied with their present living standards and are not interested in increasing further their living standards. They are interested in obtaining more leisure time. Therefore, when wage increase, they continue to the same hours or reduce the number of hours worked to maintain the same level of total income. Conclusively, it can be said that workers in low paid jobs usually supply more hours worked when wage rate increases whereas workers in high paid jobs may work the same number of hours or less hours when wage rate increases.