1.2. Supply of Inputs
The individual agent who owns the input will decide how much of a factor they want to offer for sale at each price offered for the input. A worker must decide how many units of labour (hours, days, weeks, years, etc) they will offer for sale at each possible wage rate. The supply of labour is a function of the wage rate, the value of leisure, alternatives available, taxes and other circumstances.
Generally it is believed that more labour will be offered for sale at higher wage rates, up to a point. Owners of other factors of production (land, capital, entrepreneurial ability) make decisions that determine the supply functions of those factors. Any individual worker's supply of labor will depend on her or his opportunity for income from sources other than labor and on her or his preferences between leisure and earning income. When we look at the supply of labor from the point of view of the economy as a whole, this can lead to some surprises. Some economists argue that the labor supply curve could slope backward, for at least a part of its range.
When people earn a higher wage per hour, they can earn more income for working the same or even fewer hours. When people can "have it all," they often choose to do just that – have more of all the good things. Thus, when wages per hour of labor rise, people are getting better off, and eventually they decide to take some of their increased potential income in the form of leisure rather than money. That means the quantity of labor supplied – in hours per year – is less, and the labor supply curve slopes backward (as shown) at the higher wage levels.
When we look at the supply of labor to a particular industry, we don't need to worry about this. For example, when wages paid by the potato growing industry are low, most people will find that they can make more money in other industries, and so they don't supply labor to the potato industry. When potato grower wages rise, some of those people will find that they now can earn more in the potato industry than in their alternatives, and will switch their labor supply into the potato industry. Thus, the supply curve of labor to the potato industry will be upward sloping. Since the supply of labor to a particular industry is dominated by this switching-back-and-forth from other industries, the supply curve of labor to an individual industry will usually be upward sloping, From now on, we will show them as upward sloping.
2. Equilibrium in a Market for Inputs
Labour market
Now we can put the supply and demand for labor together and discuss an equilibrium. Recall, the price of labor is the wage, shown by w, and the quantity demanded is the number of labor-hours employed, shown by L. The demand for labor is the MRP, the price of output times the marginal productivity of labor in units of output. As usual, the equilibrium price (wage) and the equilibrium quantity demanded and supplied (employment) are at the point where the supply and demand curve intersect.
Figure 3: Supply and Demand for Labor