In the labor market, the roles of firms and households are the reverse of what they are in markets for goods and services. A good such as wheat is supplied by firms and demanded by households; labor, though, is demanded by firms and supplied by households. How do people decide how much labor to supply?

As a practical matter, most people have limited control over their work hours: either you take a job that involves working a set number of hours per week, or you don’t get the job at all. To understand the logic of labor supply, however, it helps to put realism to one side for a bit and imagine an individual who can choose to work as many or as few hours as he or she likes.

Why wouldn’t such an individual work as many hours as possible? Because workers are human beings, too, and have other uses for their time. An hour spent on the job is an hour not spent on other, presumably more pleasant, activities. So the decision about how much labor to supply involves making a decision about time allocation—how many hours to spend on different activities.

By working, people earn income that they can use to buy goods. The more hours an individual works, the more goods he or she can afford to buy. But this increased purchasing power comes at the expense of a reduction in leisure, the time spent not working. (Leisure doesn’t necessarily mean time spent goofing off. It could mean time spent with one’s family, pursuing hobbies, exercising, and so on.) And though purchased goods yield utility, so does leisure. Indeed, we can think of leisure itself as a normal good, which most people would like to consume more of as their incomes increase.

How does a rational individual decide how much leisure to consume? By making a marginal comparison, of course. In analyzing consumer choice, we asked how a utility-maximizing consumer uses a marginal dollar. In analyzing labor supply, we ask how an individual uses a marginal hour.

Consider Clive, an individual who likes both leisure and the goods money can buy. Suppose that his wage rate is $10 per hour. In deciding how many hours he wants to work, he must compare the marginal utility of an additional hour of leisure with the additional utility he gets from $10 worth of goods. If $10 worth of goods adds more to his total utility than an additional hour of leisure, he can increase his total utility by giving up an hour of leisure in order to work an additional hour. If an extra hour of leisure adds more to his total utility than $10 worth of goods, he can increase his total utility by working one fewer hour in order to gain an hour of leisure.

At Clive’s optimal labor supply choice, then, his marginal utility of one hour of leisure is equal to the marginal utility he gets from the goods that his hourly wage can purchase. This is very similar to the optimal consumption rule we encountered in Chapter 10, except that it is a rule about time rather than money.

Our next step is to ask how Clive’s decision about time allocation is affected when his wage rate changes.