Chapter 16, Problem 1E

To determine

To explain:

The reason for backward bending supply curve.

Explanation of Solution

An individual has 24 hours at his disposal which can be used either between working or leisure activity. The more an individual works, less is the time spent on leisure. Working hours fetches money which is used to spend on goods and services. Leisure hours gives satisfaction which can be spent either on sleep, resting, doing hobbies or listening to music. Leisure is considered as a normal activitywhich provides satisfaction to individual. An individualhas a choice to choose the number of hours to be spent on leisure and work.

As the wage increases, an individual should either increase number of hours of working or reduce it. This depends on the strength of increase in wage rate and the substitution effect of the rise in wage rate.

Income effect has a positive relation with the leisure activity, as leisure is considered as normal good. With increase in wage rate, an individual should choose to work less and spend more time on leisure activity.

Substitution effect has a positive relation with working activity, as leisure activity is considered as an inferior good. With increase in wage rate, number of working hours gets increased and opportunity cost of leisure also increases.Since income and substitution effect works in opposite direction; so, an individual's decision depends on the strength of increase in wage rate.

Initially, as wage rate increases, substitution effect is stronger than income effect, which implies with increase in wage rate, number of working hours spent increases, considering working activity as normal good.

Later on, when income has increased enough, then income effect by passes substitution effect. An individual can think after a certain increase in wage rate, that enough amount of income is for disposal; so, leisure activity becomes a normal good. So, income effect overweighs substitution effect.

Thus, due to the income and substitution effect, the labor supply curve is backward bending.

Economics Concept Introduction

Supply curve:

The graph that represents the relationship between the cost and the quantity supplied of the goods or services is known as supply curve.