Reassessing the Labor Supply Curve

It is no exaggeration to state that the supply and demand model of price determination is the most widely accepted theory in contemporary economics. In the professional and textbook literature, this model is used to determine the price of every kind of commodity from theater tickets to corn, oil, votes and wages. However, problems can arise when a model as abstract as the theory of supply and demand is too readily applied to situations in which it may be inappropriate. Indeed, Institutional economists have long maintained that the application of the supply and demand theory to the labor market is often an important instance of such an error [Galbraith 1997; Lester 1947, 1941; Power 1999; Prasch 2000, 1999, 1998b]. This paper will argue that labor is qualitatively different from other commodities in at least one crucial attribute. Specifically, when the price of a typical commodity falls, the conventional theory of supply maintains that suppliers will substitute out of the business of providing that particular item, and devote their productive capacity to the provision of some other item. In the standard models, this substitution is thought to occur with zero transactions costs. Now this idea is not necessarily wrong. For example, it is reasonable to suppose that a low price for minivans will induce automobile manufacturers to supply more trucks or sedans. But is it plausible to apply this line of reasoning to the aggregate labor market? Or the market for unskilled labor? The problem is that most people depend upon the sale of their labor for the bulk of their income and, indeed, for their livelihood. In light of this fact, can we plausibly conclude that a low wage will induce more than a minority of people to substitute into leisure and forgo any effort to earn a living? After all, not many people