Towards a micro-founded theory of aggregate labor supply

By Andrés Erosa, Luisa Fuster and Gueorgui Kambourov

http://d.repec.org/n?u=RePEc:imd:wpaper:wp2011-13&r=dge

We document various facts about the labor supply decisions of male workers in the US over their life cycle. We then build a neoclassical model of labor markets with non-linear wages and heterogeneous agents. The key model feature for delivering periods of non-participation is the non-linear mapping between hours of work and earnings. We show that our model can go a long way towards capturing salient features of individual labor supply over the life cycle. Moreover, the aggregate response of labor supply to a one time unanticipated wage shock is much larger than predicted by the Frisch elasticity of labor supply.

This is a very active line of work, better understand the labor supply and in particular its Frisch elasticity. Determining the size the substitution effect is crucial to study labor markets through the business cycle, and unfortunately micro and macro estimates of the elasticity do not agree, by far. This paper highlights that some non-linearities may play an important role here, both in terms of estimate discrepancies and the behavior of labor markets.

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