1. is upward sloping at low real wage rates because of the substitution effect of work for leisure as wages rise but negatively sloped at high real wages due to the wealth effect of wage increases on the demand for leisure.
2. is a relationship between the quantity of employment offered and the nominal wage rate in the economy.
3. is positively sloped when the income effect of wage increases predominates and negatively sloped when the substitution effect predominates.
4. is accurately described by all of the above.
Choose the correct option.
The correct answer is given by option 1. At low wages, the substitution effect prevails---more work is done in response to higher wages because work (and income) is substituted for leisure, the opportunity cost of which rises with the rise in the wage rate. As wage rates and income levels get higher, the effect of increased wage rates on the level of wealth tends to induce workers to take more leisure. Work effort thus tends to increase less and eventually decline in response to increases in wage rates. The aggregate supply of labour thus tends to be positively sloped at low wage rates and bend back on itself, becoming negatively sloped, at high wage rates. At all times, the relevant wage rate is the real wage rate, not the nominal wage rate.
An increase in the real wage rate has two effects. First, it increases the opportunity cost of taking leisure instead of working. Second, it increases the income received from the existing work level and, hence, increases the level of wealth. As wealth increases, individuals choose more leisure and tend therefore to work less hours per day. At low wages, and low levels of wealth, the substitution effect tends to dominate---people switch from leisure to work in response to the higher opportunity cost of leisure. At high wages, and high levels of wealth, the wealth effect tends to dominate. People take more leisure because it gives them the opportunity to enjoy the income already being earned from existing levels of work while maintaining that income by earning a higher wage for the work effort expended.
That the income effect predominates at high levels of wealth is evident from the fact that as the industrialized countries have grown during the past two centuries hours worked per week have typically declined.