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Thursday, 25 August 2011

Word of the Day

Backwards Bending Supply Curve

When the wage rate is W1, the number of hours worked is L1. If wages rise to W2, the number of hours worked rises to L2. This is due to something called the substitution effect. The substitution effect relates to the fact that leisure becomes more expensive compared to the other goods that money from wages can buy (for example, the worker can now start buying food from the Asda ‘Extra Special’ range rather than ‘smart price’ products). Workers prefer to work over leisure time. The worker responds to the rise in hourly wage rates by substituting more labour over leisure time.

After wages rise to W3, labour – the number of hours worked – falls to L3. This is because of the income effect. The income effect relates to the fact that a worker can achieve a target income without working so many hours and therefore prefers more leisure time once this target income level has been reached. A worker chooses to work fewer hours to enjoy more leisure time because leisure time is a normal good, rather than an inferior good. This means that as real incomes rise, demand for leisure time – the normal good – rises as well.

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