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Backward Bending Labor Supply

So far assumed that L(S) and L(D) curves cross at a wage at which the L(S) curve slopes upward. At high wages, income effect may dominate, L(S) curve may bend backward. What if L(S) curve bends backward when it crosses the L(D) curve? Backward Bending Labor Supply Wage Wage L(S) L(D) L

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Backward Bending Labor Supply

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  1. So far assumed that L(S) and L(D) curves cross at a wage at which the L(S) curve slopes upward. At high wages, income effect may dominate, L(S) curve may bend backward. What if L(S) curve bends backward when it crosses the L(D) curve? Backward Bending Labor Supply Wage Wage L(S) L(D) L

  2. If L(S)* is more steeply sloped than L(D)*: Equilibrium wage W* still wage at which L(S) curve & L(D) curve cross Equilibrium qty. of labor transacted L* still L(S) and L(D) at which curves cross. Employer and employee surplus equal areas shown: employee surplus flawed. Backward Bending Labor Supply Wage Wage L(S) W* L(D) L* L Employee surplus Employer surplus

  3. If L(S)* is more steeply sloped than L(D)*: If wage is greater than equilibrium wage, L(S) greater than L(D) More workers seeking jobs than job vacancies firms seek to fill Wage bid down to equilibrium wage Backward Bending Labor Supply Wage Wage L(S) W(hi) W* L(D) L(D) L(S) L

  4. If L(S)* is more steeply sloped than L(D)*: If wage is lower than equilibrium wage, L(D) greater than L(S) More job vacancies firms seek to fill than workers seeking jobs Wage bid up to eq. wage Stable equilibrium: when wage  eq. wage, wage is bid back to eq. wage Backward Bending Labor Supply Wage Wage L(S) W* W(lo) L(D) L(S) L(D) L

  5. If L(D)* is more steeply sloped than L(S)*: Equilibrium wage W* still wage at which L(S) curve & L(D) curve cross Equilibrium qty. of labor transacted L* still L(S) and L(D) at which curves cross. Considered an “unstable equilibrium,” unrealistic depiction of labor market. Backward Bending Labor Supply Wage Wage L(D) L(S) W* L*

  6. If L(D)* is more steeply sloped than L(S)*: If wage is greater than equilibrium wage, L(D) is greater than L(S) More job vacancies firms seek to fill than workers seeking jobs Wage bid upward, away from W* Backward Bending Labor Supply Wage Wage L(D) L(S) W(hi) W* L(S) L(D)

  7. If L(D)* is more steeply sloped than L(S)*: If wage is less than W*, L(S) is greater than L(D) More workers seeking jobs than job vacancies firms seek to fill Wage bid downward, away from W* Unstable equilibrium; when wage  eq. wage, wage is bid away from eq. wage. Backward Bending Labor Supply Wage Wage L(D) L(S) W* W(lo) L(D) L(S)

  8. Suppose something happened to increase the quantity of labor supplied, other than a change in the employee wage: Increase in preference for consumption over leisure Decrease in employee wage of other kinds of work Decrease in non-labor income of workers Shifts in Labor Supply L(S) Wage W* L(D) L*

  9. “Increase in labor supply” Expressed with outward shift of labor supply curve Quantity of labor supplied increases independently of price. Lower equilibrium wage Higher equilibrium quantity of labor transacted Shifts in Labor Supply L(S) L(S) Wage W* W* L(D) L* L*

  10. Interpretation: At equilibrium, the quantity of labor supplied [L(S)] equals the quantity of labor demanded [L(D)]. In other words, all workers seeking jobs have jobs, and all firms have all job vacancies filled. Shifts in Labor Supply L(S) Wage W* L(D) L(D) = L(S)

  11. Interpretation: Now, there is an “increase in labor supply” This causes the quantity of labor supplied to increase and become greater than the quantity of labor demanded. In other words, the number of workers who want jobs is greater than the number of job vacancies firms seek to fill. Shifts in Labor Supply L(S) Wage W* L(D) L(D) L(S)

  12. Interpretation: As too many workers chase too few jobs, the wage is bid downward. As the wage declines, the number of people who want jobs decreases… …and the number of job vacancies firms open up and fill increases… Shifts in Labor Supply L(S) Wage W* L(D) L(D) L(S)

  13. Interpretation: …until a new equilibrium wage at which the quantities of labor supplied and demanded are equal. Since the wage decrease caused firms to open more job vacancies, the new equilibrium quantity of labor transacted is higher than the old one. Shifts in Labor Supply L(S) Wage W* L(D) L(S) = L(D)

  14. Shifts in Labor Supply L(S) L(S) L(S) L(S) Wage Wage W* W* W* W* Elastic L(D) Inelastic L(D) L* L* L* L* The greater the elasticity of labor demand, the smaller the wage decrease, the greater the employment increase from an increase in labor supply.

  15. A decrease in labor supply has the opposite effect: May be caused by increase in non-labor income, in preference for leisure over consumption Increases equilibrium wage Decreases equilibrium quantity of labor transacted Shifts in Labor Supply L(S) L(S) Wage W* W* L(D) L* L*

  16. Suppose something increased the quantity of labor demanded, other than a change in the employer wage: Increase in product demand Increase in wage* of substitute kind of labor (sub. effect dominates) Decrease in wage* of complement kind of labor Shifts in Labor Demand L(S) Wage W* L(D) L*

  17. Increase in labor demand Expressed with outward labor demand curve shift Quantity of labor demanded increases independently of price Higher equilibrium wage Higher quantity of labor transacted if L(S) curve is upward sloping Shifts in Labor Demand L(S) Wage W* W* L(D) L(D) L* L*

  18. Interpretation: At equilibrium, the quantity of labor supplied [L(S)]* equals the quantity of labor demanded [L(D)]*. In other words, all workers seeking jobs have jobs, and all firms have all job vacancies filled. Shifts in Labor Demand L(S) Wage W* L(D) L(S) = L(D)

  19. Interpretation: When there is an “increase in labor demand,” the quantity of labor demanded increases and becomes greater than the quantity of labor supplied. This means that the number of vacancies firms wish to fill is greater than the number of workers who want jobs. Shifts in Labor Demand L(S) Wage W* L(D) L(S) L(D)

  20. Interpretation: With too many firms chasing too few workers, the wage is bid upward… …causing firms to want to hire fewer workers, decreasing the quantity of labor demanded… …and causing more people to want to work, increasing the quantity of labor supplied. Shifts in Labor Demand L(S) Wage W* L(D) L(S) L(D)

  21. Interpretation: …until a new, higher equilibrium wage at which the quantities of labor supplied and demanded are equal is reached. Since the wage increase has drawn more workers into the market, the new equilibrium quantity of labor transacted is higher than the old one. Shifts in Labor Demand L(S) Wage W* L(D) L(S) = L(D)

  22. Shifts in Labor Demand L(S) L(S) Wage Wage L(D) L(D) W* L(D) L(D) W* W* W* L* L* L* L* The greater the elasticity of labor supply, the smaller the wage increase, the greater the employment increase from an increase in labor demand.

  23. Decrease in labor demand has opposite effect: May be caused by decrease in product demand, or decrease in wage* of substitute kind of labor (sub. effect dominates), etc. Decrease equilibrium wage Decreases equilibrium quantity of labor transacted Shifts in Labor Demand L(S) Wage W* W* L(D) L(D) L* L*

  24. Effect of labor demand increase is different if labor supply curve bends backward at equilibrium wage Equilibrium wage increases--by a lot Equilibrium quantity of labor transacted decreases Shifts in Labor Demand Wage L(S) W* W* L(D) L(D) L* L*

  25. Interpretation: At equilibrium, the quantity of labor supplied equals the quantity of labor demanded. All workers who want jobs have jobs, and all vacancies that firms wish to fill are filled. Shifts in Labor Demand Wage L(S) W* L(D) L(S) = L(D)

  26. Interpretation: When labor demand increases, the quantity of labor demanded increases and becomes greater than the quantity of labor supplied. In other words, the number of vacancies firms wish to fill is greater than the number of workers who want jobs. Shifts in Labor Demand Wage L(S) W* L(D) L(S) L(D)

  27. Interpretation: The wage is bid upward… …but the income effect is dominant, so the wage hike causes fewer people to want work and a decrease in the quantity of labor supplied! However, the increase in the wage also causes firms to close vacancies, also reducing the quantity of labor demanded. Shifts in Labor Demand Wage L(S) W* L(D) L(S) L(D)

  28. Interpretation: Although both L(S) and L(D) are dropping, L(D) drops faster, eventually falling enough to be equal to L(S) at a new, much higher equilibrium wage. Since the wage increase has caused fewer workers to want to work, the new equilibrium quantity of labor transacted is lower. Shifts in Labor Demand Wage L(S) W* L(D) L(S) = L(D)

  29. Decrease in labor demand has opposite effect: May be caused by decrease in product demand, or decrease in wage* of substitute kind of labor (sub. effect dominates), etc. Decreases equilibrium wage Increases equilibrium quantity of labor transacted Shifts in Labor Demand Wage L(S) W* W* L(D) L(D) L* L*

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