The determination of Wage

The supply of labour

The market supply of labour means the total number of hours of work that the population is willing to supply. This is a function of the size of population, the portion of the population willing to work and the number of hours worked by each individual.

Tradeoff between Income and Leisure

A person consumes leisure time by giving up his or her hourly wage, so the wage rate is the opportunity cost of leisure. A rise in wage rate means a change in the relative price of leisure, such change includes both the substitution effect and income effect.

Substitution effect

When the wage rate rises, the relative price of leisure increase (the budget line tilts upward), and the worker will demand less leisure and supply more work. Thus, the substitution effect of an increased wage rate is negative. That means a higher wage rate will lead the worker to consume less leisure.

Income effect

Higher wage rates mean the worker is better off. The income effect of a higher wage rate on the amount of leisure consumed depends on whether leisure is considered a superior or an inferior good.

*If leisure is a superior good, the worker will demand more leisure and supply less work. Thus the income effect of a wage rate increase is positive, meaning a higher wage rate will lead the worker to consume more leisure.

If leisure is an inferior good, the worker will demand less leisure and supply more work. Thus, the income effect of a wage rate increase is negative, meaning a higher wage rate will lead the worker to consume less leisure.