Question

In: Economics

Consultants in a particular industry are currently paid $100 per hour and the typical work day...

Consultants in a particular industry are currently paid $100 per hour and the typical work day lasts 10 hours. Demand for labour in that industry increases, resulting in the average hourly rate increasing to $150 per hour. However, a labour survey reveals that most consultants now work two fewer hours per day than they did prior to the rise in the price of their labour. A newspaper comments that this is at odds with the “law of supply”, such that higher prices should result in greater quantities supplied. Explain why individual consultants’ labour supply curves can be backward bending, such that higher wages lead to fewer hours worked, and explain whether the market labour supply curve for consultants is likely to violate the “law of supply”. Use appropriate diagrams to illustrate your answer.

please provide an explanation and diagram to support it

Solutions

Expert Solution

In labor supply market there is existence of backward lending labor supply curve which shows that with an increase in real wages, labor supply increases only to a certain extent after which it starts declining.

In the diagram we can see that when real wage rate increases beyond w2, the labor supply bends backwards leading to a decrease in labor supply from L2 to L3.

As we know there is a trade off between labor supply and leisure. The higher labor supply by a worker is, the greater would be the loss in leisure.

Now, there are two determinants of labor supply, substitution effect and income effect.

Substitution effect takes place when a higher wage leads to the worker substituting leisure for work or an increase in labor supply due to higher wages tha before.

Income effect states that the worker may reach his targeted income level by working for certain hours. Increase in wages would mean he can achieve his targeted level of income in fewer hours.

Backward bending supply curve takes place when income effect is greater than substitution effect.


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