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Summary substitution and income effects on the backward bending supply curve of labour
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substitution and income effects on the backward bending supply curve of labour
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substitution and income effects on thebackward bending supply curve of labour
As wage rates rise, at first, a person is willing to work
more, but at very high wage rates, they are not willing
to supply more of their time. This strange-looking supply
curve can be explained using the substitution and
income effects.
The substitution effect outweighs the income effect until
a certain point, at which the income effect dominates
and outweighs the substitution effect. The income effect
states that we have a target income level that will
provide us with the desired lifestyle. At very high
income levels, if our wage rate goes up, we will work
fewer hours and still earn the same target income,
allowing us to enjoy more leisure time.
The income effect creates this unusual supply curve.
However, both effects are constantly in play, with the
substitution effect dominating at lower wage rates and
the income effect dominating at higher income rates.
High earners can retire early, while those on lower
incomes must work until they receive their state
pension.
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