In mainstream economic theories, the aggregate supply of labour is the sum of the labour supplied by everyone in the economy at a given real wage rate. Individuals decide how much to work by weighing the benefits against the costs of working. To make themselves as well off as possible, individuals should choose to supply labour up to the point at which the income obtained from working an extra hour just makes up for the extra hour of leisure they have to forgo.
In reality, labour supply is a function of variables in an economy. Labour supply curve is derived from the labour-leisure trade-off. As a result, there are two effects on the amount of desired labour supplied due to a change in real wage, namely the substitution effect and the income effect
Generally, an increase in the real wage affects households’ decision of labour supply in two ways. First, an increase in the real wage increases the benefit of working an additional hour and thus increases the incentive for households to supply more labour. This effect is called the substitution effect. Secondly, an increase in the real wage increases households’ wealth. Wealthier households can afford additional leisure and thus will supply less labour. This effect is called the income effect. These two effects operate in opposite directions.
The labour supply curve of an individual relates the amount of labour supplied to the current real wage, all other things being constant. If the current real wage is measured on the vertical axis and the amount of labour supplied is measured on the horizontal axis, the labour supply curve slopes upward because an increase in the current real wage leads to an increase in the amount of labour supplied.