Backward bending supply curve of labour

In economics, a backward-bending supply curve of labour, or backward-bending labour supply curve, is a graphical device showing a situation in which as real, or inflation-corrected, wages increase beyond a certain level, people will substitute leisure (non-paid time) for paid worktime and so higher wages lead to a decrease in the labour supply and so less labour-time being offered for sale.

The "labour-leisure" tradeoff is the tradeoff faced by wage-earning human beings between the amount of time spent engaged in wage-paying work (assumed to be unpleasant) and satisfaction-generating unpaid time, which allows participation in "leisure" activities and the use of time to do necessary self-maintenance, such as sleep. The key to the tradeoff is a comparison between the wage received from each hour of working and the amount of satisfaction generated by the use of unpaid time.

Such a comparison generally means that a higher wage entices people to spend more time working for pay; the substitution effect implies a positively sloped labour supply curve. However, the backward-bending labour supply curve occurs when an even higher wage actually entices people to work less and consume more leisure or unpaid time.

As wages increase above the subsistence level (discussed below), there are two considerations affecting a worker's choice of how many hours to work per unit of time (usually day, week, or month). The first is the substitution or incentive effect. With wages rising, the tradeoff between working an additional hour for pay and taking one extra hour of unpaid time changes in favor of working. Thus, more hours of labour-time will be offered at the higher wage than the lower one. The second and countervailing effect is that the hours worked at the old wage rate now all gain more income than before, creating an income effect, which encourages more leisure to be chosen because it is more affordable. Most economists assume that unpaid time (or "leisure") is a normal good and so people want more of it as their incomes (or wealth) rise. Since a rising wage rate raises incomes, all else constant, the attraction of unpaid time rises, eventually neutralising the substitution effect and causing the backward bend.

The graph shows that if real wages were to increase from W1 to W2, the substitution effect for an individual worker outweighs the income effect; therefore, the worker would be willing to increase hours worked for pay from L1 to L2. However, if the real wage increased from W2 to W3, the number of hours offered to work for pay would fall from L2 to L3 since the strength of the income effect now exceeds that of the substitution effect; the utility to be gained from an extra hour of unpaid time is now greater than the utility to be gained from extra income that could be earned by working the extra hour.

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