HOUSEHOLD PRODUCTION AND LABOUR SUPPLY

Introduction The response of aggregate labour supply to changes in the real wage has been a question of interest to economists for some time. For example, the notion of a backward‐bending supply curve for labour is commonly known, though not universally accepted. The question is of more than academic interest; it has direct relevance to tax policy, because an income tax in effect lowers the real wage, which is then likely to cause people to substitute out of work into leisure. This article evaluates the aggregate labour supply curve from within a household production framework and finds that, under plausible circumstances, the aggregate labour supply curve is likely to be very inelastic. (The model here actually considers only a subset of the long‐run aggregate supply of labour. Long‐run questions of fertility are not addressed here, nor is the labour force participation rate, which might vary in the short run in response to a change in the real wage. This article considers only the work effort of someone who is already in the labour force.) For a case derived below, the aggregate labour supply curve is always perfectly inelastic, meaning that for proportional changes in the tax structure, the quantity of labour supplied will not be a function of the tax rate. (Gwartney and Stroup[1] give a good overview of the traditional arguments along with their own argument that an income tax increase must reduce work effort).