who already work positive hours, a wage increase will have both income and substitution effect. An
income effect from wage increase will induce more leisure and less working hours and a
substitution effect (from the increase of the opportunity cost of leisure) will induce more working
hours and less leisure. The overall effect of labour supply depends on the relative magnitudes of
the two. This result is important to explain why labour supply curve can be backward binding. For an
individual, the initial small increase of the wage rate may have a dominated substitution effect,
which leads him/her to work more hours, however, as wage grows higher and higher, income effect
grows larger and may become greater in magnitudes than the substitution effect, therefore, the
individual will eventually reduce his/her working hours.
The empirical evidences on the estimate of elasticity of labour supply have further proved the
results from income-leisure model. The shape of the labour supply curve really depends on the
relative magnitudes of the income elasticity and compensated (substitution effect) elasticity. For
example, Hansson and Stuart (1985) have summarized that, the overall elasticity of labour supply
from a wage change is 0.10, uncompensated elasticity is about 0.25 and income elasticity is about
-0.15. However, male and female may have a different labour supply schedule. Generally, for males,
the labour supply schedule is likely to be slightly backward bending. For females, the labour supply
schedule is more strongly forward sloping, shown a strong positive substitution elasticity
outweighing the weak negative income elasticity. This empirical evidence can also be used in
explaining the fact that the male participation rate is generally declining with national income and
women's participation rises with nation income (Figure 2.3). For countries that average income is
higher, higher wage rate induced strong income elasticity for males and strong substitution elasticity
for females, which leads to lower participation rate for males and higher participation rate for
females.
References
Short Answer Learning Objective:
02-02 Illustrate
graphically how the
labour supply model
reflects the income
and leisure trade-
offs that consumers
face in deciding
whether and how
much to work.
Learning Objective: 02-04 Explain, using
diagrams, how an increase in the wage
rate leads to offsetting income and
substitution effects, and how this yields
an ambiguous effect of wage changes on
labour supply.
Difficulty:
Medium
Learning Objective:
02-03 Distinguish
theoretically
between the work
choices made by
individuals and the
economic
opportunities that
they choose from.
Learning Objective: 02-05 Interpret the
economic and other factors affecting a
married woman's decision to work, and
show how this decision can be captured
within the labour supply model.