Backward Bending Supply Curve

Introduction

In economics, wage determination in the labour market is an important topic. Forces of demand for labour and supply of labour determine the equilibrium wage rate in a free labour market. Households supply labour and the supply of labour means the willingness and ability of households to sell labour at various wage rates in a given time period. The supply of labour is discussed for an individual worker, for the whole market and for an individual firm. In this article, we will explain the supply of labour by an individual worker.

Backward Bending Labour Supply Curve

For an individual worker, the supply of labour is the number of hours for which he/she is willing and able to work at various wage rates in a given time period. For an individual worker, labour supply curve is backward bending. This backward bending supply curve, or backward bending labour supply curve, is basically a graphical representation of the response of an individual worker towards wage increase where, when real wages increase to a certain level, the worker will substitute time previously devoted to paid work for leisure, due to which labour supply decreases and so less time is being offered by workers for work.

This supply curve for an individual worker shows an increasing supply of labour at first as wage rate rises, but when the wage rate further rises, the supply curve bends backward and shows a falling supply of labour. In labour markets, the labour supply curve for an individual worker is backward bending because, after a certain time, an increase in wages can lead to a decline in labour supply. This happens when increased wages provoke workers to work less and enjoy more leisure time.

Labour Leisure Tradeoff

A tradeoff faced by wage-earning individuals between the amount of time spent in working wage-paying work and satisfaction-generating unpaid time that allows individuals’ participation in leisure activities and the productive use of time in paying attention to important self-maintenance, like sleep, is called the labour leisure tradeoff. A basic key to this work-leisure tradeoff is the comparison between the wage received on each working hour and the amount of satisfaction created by the use of unpaid time. 

An individual worker has to make a choice between work and leisure as a response to wage increase. Workers responses to wage increases are of the following two types:.

Substitution Effect

The response of a worker to increase the number of working hours when wage rate increases is called substitution effect or incentive effect. In other words, the substitution effect of wage increase states that a higher wage rate makes work more attractive than leisure. Therefore, in response to a wage increase, the supply of labour increases and the worker gets a higher income.

The opportunity cost of taking leisure is the prevailing wage rate. When wage rate increases, leisure will become expensive because higher wage will be given up in taking leisure. So worker will substitute leisure with work. Due to the substitution effect, the hours of work increase with an increase in the wage rate.

For example, if a person has large expenses and has no interest in enjoying leisure time, the substitution effect has more importance in this case. If wage rates increase, it provides a great incentive to work extra hours. In this way, the worker can get increased income and can afford to buy more goods or services.

Income Effect

The response of a worker to decrease the number of working hours when wage rate increases is called income effect. In other words, the income effect of a wage increase states that a greater wage means that workers can achieve a greater target income by working fewer hours. Therefore, if the wage rate increases after a certain level, it makes it easy for workers to get enough income by working fewer hours.

So, worker will substitute work with leisure. Due to income effect, when wage rate increases, worker will decrease the number of working hours.

For example, if a person has only a few demands and is more interested in enjoying leisure time, his goal may be to get $36,000 per year, and after that he can maximise his time allocation of leisure time. In this case, after an increase in the wage rate above $36,000, the income effect dominates, and along with higher wages, he can afford to have more leisure time. This income effect provides the main reason for the backward-bending supply of labour.

Graph

The following graph illustrates the labour supply curve for an individual worker, which is backward bending.

The above graph is plotted between wage rate (vertical axis) and labour hours worked (horizontal axis). In this graph, if real wages increase from W₁ to W₂, the substitution effect for an individual worker becomes greater than the income effect. Due to this stronger substitution effect, employees are more willing to increase work hours for pay from L₁ to L₂. This explains the logic of an upward slope of the graph. However, when real wages increase from W₂ to W₃, the number of hours available to work for pay decreases from L₂ to L₃. This is due to the presence of a strong income effect, which means that the marginal utility to be obtained from an extra hour of unpaid time is greater than the utility to be obtained from extra income that could be gained by working extra hours. So the income remains the same or even increases by working fewer total hours.

This graph only explains the effect of changing wage rates on workers who were already subjected to those rates, and only those individuals’ labour supply response was noticed. This graph did not consider the additional labour supplied by those workers that are working in other sectors or are now unemployed and seemed to be more attracted to the jobs in the sectors because of higher wages.

Factors Affecting Labour Supply

The following are some factors that affect labour supply:

Motivation for Work

Workers are motivated by many other factors instead of hourly wages. Sometimes, workers stay at the particular type of job until they can feel the satisfaction of completing it. These kinds of motivations can exceed wages.

Job Contracts

In the real world, it is not easy for workers to choose the exact number of working hours. Many firms hire workers on fixed contracts. Even if wages rise, they are not allowed to work an extra few hours per week.

Assumptions for Labour Supply Theory

It is vitally important to understand that with the labour supply curve, there must be a set of assumptions that keep the curve backward bending. The following are some assumptions about the theory of labour supply:

Free to Work

Workers are free to choose whether they will work and how many hours they will be willing to work easily. It is important to understand that workers are the main focus of the labour supply theory. This theory is based on the concept that only workers can choose how much output time they are willing to work. If workers are not willing to work, this means that this is working leisure for workers in terms of time.

No Contractual Obligations

There are no contract-based obligations for workers to work a particular number of hours. The contractual obligations will only involve the labour supply curve, not the number of hours worked.

Utility-Maximising Agents

In terms of the economy, workers always work hard only to achieve the maximum output and the most money. That is why workers are utility-maximising agents.

Disutility

According to this theory, it is also assumed that work provides disutility, which must be indemnified for by paying handsome wages.

Normal Good

It is assumed that unpaid leisure time is always considered a normal good.

Price-Takers

Both firms and workers are price-takers due to the highly competitive labour market. 

Reservation Wage

The wage that workers received is a form of reservation wage or value wage because workers will have a particular amount of wage that can take them away from leisure. This situation is known as an opportunity cost-minimising situation for workers.

Inverted S-Shaped Supply Curve

The supply curve may also be curved backward for a completely different reason, near the subsistence level, at lower wages. That effect creates an inverted S or a backward S-shaped curve. In the above-shown graph, a tail is added at the bottom of the labour supply curve, along with the quantity of labor supplied decreasing as wages increase. Because households face some low-level income required to meet subsistence needs, at the lowest wage rate, decreasing wages increases the amount of labour time available for sale. Similarly, an increase in wages decreases the amount of labour time offered for sale, and this is how households and individuals take advantage of higher wages to spend time on needed self- and family-maintenance activities.

Applied Studies on the Backward Bending Supply Curve

Research into the labour market of Canada revealed empirical evidence about a backward supply curve for labour, particularly among female workers in Canada. The study also found that the substitution effect is higher among those workers who live alone as compared to those women who live with their partners earning a wage. It was also found that young women workers have a greater substitution effect and respond positively to higher wages by supplying more labour to the market.

According to Rahman, Adib J., in 2013, the wage has a significant positive effect on the work hours until a turning point of negative $10.9/hour is reached; apart from this value, the wage has an overall negative impact on work hours. This means that work hours increase with wage at a relatively lower rate, and this relation provides a backward-bending labour supply of canadian women. The elasticity is -0.02 between mean work hours and wage rate.

Limitations of Backward Bending Supply Curve

The following are some limitations of the backward bending supply curve:

Higher Pay for Overtime Hours

Paying higher wages for overtime hours can reduce the effect of the backward bend of the labour supply curve by raising wages only for hours worked for a particular amount. Overtime sustains the substitution effect at a high supply of labour. Therefore, the income effect from the wage rise on all the previous hours worked is removed. As a result, paying higher hourly overtime can encourage workers to work more hours than if the same high rate is paid on all worked hours.

Opportunity-Cost Minimising Situation

Another limitation of this supply curve is that workers must have a willingness to work. Workers have a specific amount of wage that drags them away from leisure. This wage is called reservation wage. This wage set an opportunity-cost-minimising situation for workers, as workers are always willing to attain the most output or high money they can. But if workers are not provided with enough wages to clear the reservation wage boundary, then the workers will not work. Instead, they consume their utility with leisure for a greater work-life balance.

The Laffer Curve and Labour Supply

The shape of the Laffer curve is also backward bending, as shown below.

The above graph is plotted between tax rates and tax revenue. The backward bending supply curve also has implications for tax policy. 

According to the Laffer curve, at particular tax rates, cutting income tax can lead to a rise in tax revenue. Here, the argument is that lower tax rates and higher wages increase the incentive to work.

But the Laffer curve assumes that substitution effect dominates. But cutting taxes and increases in wages can lead to an increase in supply, and therefore, governments also gain increased tax revenues from cutting tax rates.

Therefore, if the supply curve is bending backward, then cutting tax rates may not increase the supply for labour. But it is possible that some workers may react to tax cuts by working less; as a result, they can gain only their target income by working fewer hours.

Conclusion

In conclusion, a backward-bending labour supply curve is mostly affected by the wage rate in labor economics. According to the backward bending supply curve, the supply curve for an individual worker shows reduced supply when the wage rate rises after certain level. Backward-bending labor supply curve has also some limitations. These limitations state that workers should be allowed to choose their hours of work and should be paid high wages for overtime hours that workers worked. There are also some assumptions, like disutility, free to work, no contractual obligations, etc.