Up to this point we have focused on the demand for factors, which determines the quantities demanded of labor, capital, or land by producers as a function of their factor prices. What about the supply of factors?

In this section we focus exclusively on the supply of labor. We do this for two reasons. First, in the modern U.S. economy, labor is the most important factor of production, accounting for most of factor income. Second, as we’ll see, labor supply is the area in which factor markets look most different from markets for goods and services.

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.

Suppose that Clive’s wage rate doubles, from $10 to $20 per hour. How will he change his time allocation?

You could argue that Clive will work longer hours, because his incentive to work has increased: by giving up an hour of leisure, he can now gain twice as much money as before. But you could equally well argue that he will work less, because he doesn’t need to work as many hours to generate the income to pay for the goods he wants.

As these opposing arguments suggest, the quantity of labor Clive supplies can either rise or fall when his wage rate rises. To understand why, let’s recall the distinction between substitution effects and income effects that we learned in Chapter 10 and its appendix. We saw there that a price change affects consumer choice in two ways: by changing the opportunity cost of a good in terms of other goods (the substitution effect) and by making the consumer richer or poorer (the income effect).

Now think about how a rise in Clive’s wage rate affects his demand for leisure. The opportunity cost of leisure—the amount of money he gives up by taking an hour off instead of working—rises. That substitution effect gives him an incentive, other things equal, to consume less leisure and work longer hours. Conversely, a higher wage rate makes Clive richer—and this income effect leads him, other things equal, to want to consume more leisure and work fewer hours, because leisure is a normal good.

So in the case of labor supply, the substitution effect and the income effect work in opposite directions. If the substitution effect is so powerful that it dominates the income effect, an increase in Clive’s wage rate leads him to supply more hours of labor. If the income effect is so powerful that it dominates the substitution effect, an increase in the wage rate leads him to supply fewer hours of labor.

We see, then, that the individual labor supply curve—the relationship between the wage rate and the number of hours of labor supplied by an individual worker—does not necessarily slope upward. If the income effect dominates, a higher wage rate will reduce the quantity of labor supplied.

Figure 19-11 illustrates the two possibilities for labor supply. If the substitution effect dominates the income effect, the individual labor supply curve slopes upward; panel (a) shows an increase in the wage rate from $10 to $20 per hour leading to a rise in the number of hours worked from 40 to 50. However, if the income effect dominates, the quantity of labor supplied goes down when the wage rate increases. Panel (b) shows the same rise in the wage rate leading to a fall in the number of hours worked from 40 to 30. (Economists refer to an individual labor supply curve that contains both upward-sloping and downward-sloping segments as a “backward-bending labor supply curve”—a concept that we analyze in detail in this chapter’s appendix.)

Is a negative response of the quantity of labor supplied to the wage rate a real possibility? Yes: many labor economists believe that income effects on the supply of labor may be somewhat stronger than substitution effects. The most compelling piece of evidence for this belief comes from Americans’ increasing consumption of leisure over the past century. At the end of the nineteenth century, wages adjusted for inflation were only about one-eighth what they are today; the typical workweek was 70 hours, and very few workers retired at age 65. Today the typical workweek is less than 40 hours, and most people retire at age 65 or earlier. So it seems that Americans have chosen to take advantage of higher wages in part by consuming more leisure.

Now that we have examined how income and substitution effects shape the individual labor supply curve, we can turn to the market labor supply curve. In any labor market, the market supply curve is the horizontal sum of the individual labor supply curves of all workers in that market. A change in any factor other than the wage that alters workers’ willingness to supply labor causes a shift of the labor supply curve. A variety of factors can lead to such shifts, including changes in preferences and social norms, changes in population, changes in opportunities, and changes in wealth.

Changes in Preferences and Social Norms Changes in preferences and social norms can lead workers to increase or decrease their willingness to work at any given wage. A striking example of this phenomenon is the large increase in the number of employed women—particularly married employed women—that has occurred in the United States since the 1960s. Until that time, women who could afford to largely avoided working outside the home. Changes in preferences and norms in post-World War II America (helped along by the invention of labor-saving home appliances such as washing machines, increasing urbanization of the population, and higher female education levels) have induced large numbers of American women to join the workforce—a phenomenon often repeated in other countries that experience similar social and technological forces.

Changes in Population Changes in the population size generally lead to shifts of the labor supply curve. A larger population tends to shift the labor supply curve rightward as more workers are available at any given wage; a smaller population tends to shift the labor supply curve leftward. From 1990 to 2008, the U.S. labor force has grown approximately 1% per year, generated by immigration and a relatively high birth rate. As a result, from 1990 to 2008 the U.S. labor market had a rightward-shifting labor supply curve. However, while the population continued to grow after 2008, the size of the labor force began to shrink beginning in 2009 as workers, disillusioned by bad job prospects, left the labor force. As a result, since 2009 the U.S. labor supply curve has been shifting leftward.

Changes in Opportunities At one time, teaching was the only occupation considered suitable for well-educated women. However, as opportunities in other professions opened up to women starting in the 1960s, many women left teaching and potential female teachers chose other careers. This generated a leftward shift of the supply curve for teachers, reflecting a fall in the willingness to work at any given wage and forcing school districts to pay more to maintain an adequate teaching staff. These events illustrate a general result: when superior alternatives arise for workers in another labor market, the supply curve in the original labor market shifts leftward as workers move to the new opportunities. Similarly, when opportunities diminish in one labor market—say, layoffs in the manufacturing industry due to increased foreign competition—the supply in alternative labor markets increases as workers move to these other markets.

Changes in Wealth A person whose wealth increases will buy more normal goods, including leisure. So when a class of workers experiences a general rise in their wealth levels—say, due to a stock market boom—the income effect from the wealth increase will shift the labor supply curve associated with those workers leftward as workers consume more leisure and work less. Note that the income effect caused by a change in wealth shifts the labor supply curve, but the income effect from a wage rate increase—as we discussed in the case of the individual labor supply curve—is a movement along the labor supply curve. The following Economics in Action illustrates how such a change in the wealth levels of many families led to a shift of the market labor supply curve associated with their employable children.