page_title: Labour economics
section_title: Neoclassical microeconomic model – Supply
hierarchical_section_title: Labour economics / Neoclassical microeconomics of labour markets / Neoclassical microeconomic model – Supply
caption_attribution_description: English: The central knoll at Tompkins Square Park in New York City where people sunbathe and relax.
context_page_description: Labour economics seeks to understand the functioning and dynamics of the markets for wage labour. Labour is a commodity that supplied by labourers in exchange for a wage paid by demanding firms.
  Labour markets or job markets function through the interaction of workers and employers. Labour economics looks at the suppliers of labour services and the demanders of labour services, and attempts to understand the resulting pattern of wages, employment, and income. Labour markets are normally geographically bounded, but the rise of the internet has brought about a 'planetary labour market' in some sectors.
  Labour is a measure of the work done by human beings. It is conventionally contrasted with such other factors of production as land and capital. Some theories focus on human capital. Labour is unique to study because it is a special type of good that cannot be separated from the owner. A labour market is also different from other markets in that workers are the suppliers and firms are the demanders.
context_section_description: Households are suppliers of labour. In microeconomic theory, people are assumed to be rational and seeking to maximize their utility function. In the labour market model, their utility function expresses trade-offs in preference between leisure time and income from time used for labour. However, they are constrained by the hours available to them.
  Let w denote the hourly wage, k denote total hours available for labour and leisure, L denote the chosen number of working hours,  π denote income from non-labour sources, and A denote leisure hours chosen. The individual's problem is to maximise utility U, which depends on total income available for spending on consumption and also depends on the time spent in leisure, subject to a time constraint, with respect to the choices of labour time and leisure time:
  This is shown in the graph below, which illustrates the trade-off between allocating time to leisure activities and allocating it to income-generating activities. The linear constraint indicates that every additional hour of leisure undertaken requires the loss of an hour of labour and thus of the fixed amount of goods that that labour's income could purchase. Individuals must choose how much time to allocate to leisure activities and how much to working. This allocation decision is informed by the indifference curve labelled IC₁. The curve indicates the combinations of leisure and work that will give the individual a specific level of utility. The point where the highest indifference curve is just tangent to the constraint line (point A), illustrates the optimum for this supplier of labour services.
  If consumption is measured by the value of income obtained, this diagram can be used to show a variety of interesting effects. This is because the absolute value of the slope of the budget constraint is the wage rate. The point of optimisation (point A) reflects the equivalency between the wage rate and the marginal rate of substitution of leisure for income (the absolute value of the slope of the indifference curve). Because the marginal rate of substitution of leisure for income is also the ratio of the marginal utility of leisure (MUᴸ) to the marginal utility of income (MUY), one can conclude:
  where Y is total income and the right side is the wage rate.
  If the wage rate increases, this individual's constraint line pivots up from X,Y₁ to X,Y₂. He/she can now purchase more goods and services. His/her utility will increase from point A on IC₁ to point B on IC₂.
  To understand what effect this might have on the decision of how many hours to work, one must look at the income effect and substitution effect.
  The wage increase shown in the previous diagram can be decomposed into two separate effects. The pure income effect is shown as the movement from point A to point C in the next diagram. Consumption increases from YA to YC and – since the diagram assumes that leisure is a normal good – leisure time increases from XA to XC. (Employment time decreases by the same amount as leisure increases.)
  But that is only part of the picture. As the wage rate rises, the worker will substitute away from leisure and into the provision of labour—that is, will work more hours to take advantage of the higher wage rate, or in other words substitute away from leisure because of its higher opportunity cost. This substitution effect is represented by the shift from point C to point B. The net impact of these two effects is shown by the shift from point A to point B. The relative magnitude of the two effects depends on the circumstances. In some cases, such as the one shown, the substitution effect is greater than the income effect (in which case more time will be allocated to working), but in other cases, the income effect will be greater than the substitution effect (in which case less time is allocated to working). The intuition behind this latter case is that the individual decides that the higher earnings on the previous amount of labour can be "spent" by purchasing more leisure.
  If the substitution effect is greater than the income effect, an indi
caption: The neoclassical model analyzes the trade-off between leisure hours and working hours
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