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Labor-leisure tradeoff and the labor supply curve

The basis of the labor supply curve is the tradeoff of labor and leisure. When wages increase, the opportunity cost of leisure increases and people supply more labor. Interestingly, this is not always the case! At higher wages, the marginal benefit of higher wages becomes lower and when it drops below the marginal benefit of leisure, people switch to more leisure and less labor. This leads to the rather unusual looking backward bending labor supply curve.

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Video transcript

- [Instructor] So let's keep talking about labor as a factor of production. In particular we're going to think about the supply curve of labor. So when you're thinking about the supply or the demand curve for elite labor, when you're thinking about quantity, you could just view that as hours worked in a certain time period. Hours worked. And then, for the price of labor you could just do that as wages. And we've already thought about what the demand curve for labor would look like. At high wages, not a lot of folks will want to use that labor, it's going to be so expensive. They might not even be able to afford it, and then as wages come down, more people will generally want, will demand that labor, and so they will want more hours for folks to work, and so this would be our demand curve. Or we could call this our labor demand curve. Now what about the labor supply curve? What do you think that's going to look like? Well, not a trick question. When wages are low, a lot folks might say hey, I have other things to do with my time, but then as wages get higher and higher they might trade off those other things. Doing those other things in some ways has a higher opportunity cost, it gets more expensive. And so they might trade off those other things for working. And so they might collectively work more and more hours, and so as wages go up, generally speaking, hours worked goes up. So this is a fairly classic looking labor labor supply curve. And this dynamic, that I just talked about, where people are trying to trade off whether they work or whether they do other things, this is typically referred to as the labor-leisure leisure trade off. Now, in everyday language, when you use the word leisure, it's usually referred to you're relaxing or spending time with friends or enjoying yourself in some ways, but when people talk about the labor-leisure trade off in economics, they're really talking about labor or anything that is not labor. So, leisure would include sleeping or eating or using the restroom, all of those would be included, so it really should be called the labor, not-labor trade off, but I guess that doesn't sound as good as labor-leisure trade off. And so what you really see happening here is this wages are higher and higher people are willing to trade off leisure, I'll put that in quotes for labor. Now, the effect that we often talk about, why that is, and in a lot of ways that's common sense, that's the substitution effect. Substitution effect. As wages go higher, you could view the opportunity cost of leisure gets more and more expensive and if anything gets more expensive, you try to substitute it with other things, in this case you could substitute it with more labor, by just working more. Now there is an interesting dynamic that some people talk about, which is the income effect. Which is the income effect. And the income effect is as your wages go up you tend to want to buy or demand more of everything. And you could view leisure as a good that you, as a worker might want. So there might be dynamic that if income gets above a certain level, that you actually might not wanna work more. That you actually might want more leisure because you have more than enough to supply all of your needs. And so if you wanted to imagine what a labor supply curve would look like if you could imagine the income effect kicking in at higher wages, it actually could look something like this. At low wages, it could look very similar to what we just described, but then there might be some wage where people are like you know what, I have enough money and rather than just working that extra hour I actually might want to spend that time with my family or go on vacation and in a lot of ways it's a very healthy mindset, as my personal opinion, I don't think enough people have that mindset, but if that were the case, at some point when wages get to a certain point people actually might want to work less. And so you would have this backward bending labor supply curve. So let me write this. This is a labor supply curve supply curve with the income effect after a certain point. Income effect. So it's an interesting thing to think about. Is there a certain income level above which people say, you know what, I have enough and rather than work harder, I might work a little bit less. Interesting to think about.