1. Labour Supply
Two measures reflect two aspects of the worker’s labour supply decision: (i) participation – that is, whether to work or not work; and (ii) intensity – that is, how many hours to work. It is easier if we consider intensity first: conditional on having decided to work, what factors govern the worker’s choice of how many hours of work to supply?
THE WORKER: CHOOSING HOURS OF WORK
The Price of Leisure
People work for a variety of reasons. The most obvious is to earn the income. Many people – though not all – find their work fulfilling and interesting. Still, even those people, will generally prefer another hour of leisure to another hour of work. It is, therefore, reasonable to assume that leisure is a good.

2. Goods generally have a price. Yet there is no market for leisure
Goods generally have a price. Yet there is no market for leisure. Even though there is no explicit price, there is an implicit price or opportunity cost. The OPPORTUNITY COST of any choice is the value of the best alternative choice that it forecloses. The implicit price of leisure is its opportunity cost, which is measured by the real wage (w/p). The term real wages refers to wages that have been adjusted for inflation. This term is used in contrast to nominal wages or unadjusted wages. Real wages provide a clearer representation of an individual's wages.

3. The labour-Leisure Choice
Once we see leisure as a good and the real-wage rate as its price, it is easier to understand the choices a worker faces. There are 168 hours in a week. If a worker chooses not to work at all, he enjoys 168 hours of leisure, but forgoes the income needed to buy any other goods. If the worker instead takes fewer hours of leisure, he supplies labour l = 168 – hours of leisure, and he gains the ability to purchase goods worth w/p × l. The problem for the worker is to choose the hours of labour (l ) that at the margin makes the psychic value of a small loss further loss of leisure time (i.e., a small increase in labour time) exactly equal to the psychic value of the small gain in consumption goods that would be purchased by that labour.

4. INCOME EFFECT. How would your supply of labour change if you could receive the income that results from the increased wage rate without facing a changed opportunity cost of leisure?
As a general rule, an increase in income ceteris paribus increases the demand for all goods. The extra $20 per week would permit you to buy more goods, including leisure without reducing your purchases of other goods. The reduction in the supply of labour as the result of an increase in income is called the income effect.

5. SUBSTITUTION EFFECT
If the wage rate rose would people work more or less? As a general rule, whenever ceteris paribus the price of anything rises relative to alternatives, the demand for it decreases. Here the price of leisure (its opportunity cost) has risen relative to the price of other goods, the supply of labour would rise. The change in the wage rate encourages people to substitute the now cheaper goods (what you buy using your wage) for the now more expensive leisure. The increase in the supply of labour as the result of an increase in the price (or opportunity cost) of leisure is called the SUBSTITUTION EFFECT.

6. The labour-supply Curve
The following figure represents the worker’s labour-supply decision. Look first at panel (A). Suppose that at point A, where the real wage is (w/p)1, the worker decides that providing l hours of work balances the advantages of a little more consumption against a little more leisure at the margin. Now consider what happens when the real wage rises to (w/p)2. There is a substitution effect shown by the arrow pointing to the right, which encourages the worker to supply more labour. The size of the substitution effect is measured by the length of the arrow.
There is also an income effect shown by the arrow pointing to the left, which encourages the worker to supply less labour.

7. The Slope of the labour-Supply Curve

8. The net effect is measured by the difference between the substitution and income effects shown at point B. so that an increase in the wage rate increases the worker’s supply of labour to l2 to the right of l1. If the substitution effect is always stronger, then the labour supply curve slopes upward.
Substitution effects are not necessarily stronger than income effects. Panel (B) shows the construction of the labour-supply curve, starting from point C, when income effects are stronger than substitution effects. When the real-wage rate increases from (w/p)1 to (w/p)2, the dominant income effect overwhelms the substitution effect, and labour supply (point C) falls from l1 to l2. If income effects are stronger for all wage rates above (w/p)1, then the labour-supply curve will slope downward toward point C: higher real wage rates lower labour supply.

9. Although the labour-supply curve can slope downward towards a point like A, it is not reasonable to believe that it could slope downward for every possible wage rate. At very low wage rates it is more reasonable to suppose that, with very low incomes, the worker’s need for food, clothing, shelter, and other “essential” goods, the income effect is weak and the substitution effect is strong. We should, therefore, expect the labour-supply curve to be upward sloping when wage rates are low. Hence labour supply would be backward bending.

10. Backward-bending labour-supply Curve